-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, CrBiiAptFBotpBY3X1OqUWTAARPXFetjjXheYERuGcFJoo0t6dbhScjpZUxjyXSy Yuc3nQrhHqa+/wSLTuYYvg== 0000950109-00-001268.txt : 20000331 0000950109-00-001268.hdr.sgml : 20000331 ACCESSION NUMBER: 0000950109-00-001268 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000330 FILER: COMPANY DATA: COMPANY CONFORMED NAME: TRI COUNTY FINANCIAL CORP /MD/ CENTRAL INDEX KEY: 0000855874 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 520692188 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-18279 FILM NUMBER: 587404 BUSINESS ADDRESS: STREET 1: 3035 LEONARDTOWN RD STREET 2: P O BOX 38 CITY: WALDORF STATE: MD ZIP: 20601 BUSINESS PHONE: 3016455601 MAIL ADDRESS: STREET 1: 3035 LEONARDTOWN ROAD CITY: WALDORF STATE: MD ZIP: 20601 10-K405 1 FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------------------- FORM 10-K [X] ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the fiscal year ended December 31, 1999 OR [_] TRANSITIONAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934. For the transition period from to -------- -------- Commission File Number: 0-18279 ------------------ TRI-COUNTY FINANCIAL CORPORATION ------------------------------------------------------- (Exact Name of Registrant as Specified in Its Charter) Maryland 52-1652138 - ---------------------------------- ------------------- (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) 3035 Leonardtown Road, Waldorf, Maryland 20601 - ----------------------------------------- ----------- (Address of Principal Executive Offices) Zip Code Registrant's telephone number, including area code (301) 645-5601 ----------------- Securities registered pursuant to Section 12(b) of the Exchange Act: None ---- Securities registered pursuant to Section 12(g) of the Exchange Act: Common Stock, par value $.01 per share -------------------------------------- (Title of Class) Indicate by check mark whether the registrant (l) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO ----- ----- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] As of March 21, 2000, there were issued and outstanding 795,515 shares of the registrant's common stock. The registrant's voting stock is not regularly and actively traded in any established market and there are no regularly quoted bid and asked prices for the registrant's common stock. The registrant believes the approximate trading price for the stock to be $26.38 per share for an approximate aggregate market value of voting stock held by non-affiliates of the registrant of $15.2 million. For purposes of this calculation, the shares held by directors and executive officers of the registrant and by any stockholder beneficially owning more than 5% of the registrant's outstanding common stock are deemed to be shares held by affiliates. DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of Annual Report to Stockholders for the Fiscal Year Ended December 31, 1999. (Parts I and II) 2. Portions of Proxy Statement for the 2000 Annual Meeting of Stockholders. (Part III) PART I Item 1. Business - ----------------- The Corporation. Tri-County Financial Corporation (the "Corporation") is a Maryland corporation that serves as the holding company of Community Bank of Tri-County ("Community Bank" or the "Bank"). The Corporation engages in no significant activity other than holding the stock of the Bank and operating the business of a Maryland chartered commercial bank through the Bank. Accordingly, the information set forth in this report, including financial statements and related data, relates primarily to the Bank and its subsidiaries. The Corporation's executive offices are located at 3035 Leonardtown Road, Waldorf, Maryland. Its telephone number is (301) 645-5601. The Bank. The Bank is a Maryland chartered commercial bank which conducts full service commercial banking operations throughout the southern Maryland area. The primary financial services provided include mortgage loans on residential, construction and commercial real estate and various types of consumer lending, as well as offering demand deposits, savings products and safe deposit boxes. Since its conversion from a federally chartered savings and loan association to a state commercial bank in March of 1997, the Bank's business plan has focused on expanding its business and consumer loan portfolios and increasing the level of its transactional accounts and business deposits. In 1998, the Bank entered into an agreement with UVEST Financial Services Group, Inc. under which the Bank offers investment in various financial products to Bank customers. Under this arrangement, a dual employee of the brokerage service and the Bank sells various investments, including mutual funds, annuities and stocks. The Bank receives a share of the commissions paid by the fund or insurance agency when the customer makes a purchase. The Bank began the UVEST arrangement in late 1998 and. For further information concerning the UVEST arrangement, including the income generated by it during 1999, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Corporation's 1999 Annual Report to Stockholders (the "Annual Report") which is attached hereto as Exhibit 13 and incorporated herein by reference. Recent Events In 1999, the Bank received regulatory approval to have as an affiliate a passive investment company. Tri-County Investment Corporation (the "Investment Company") was established by the Bank as a wholly owned, Delaware-incorporated subsidiary to hold and manage a portion of the Bank's investment securities portfolio. Formation of the Investment Company provides the Bank with the opportunity to reduce the overall tax expense of the Bank since passive investment corporations are not subject to Delaware or Maryland state taxes. In 1999, the Bank received regulatory approval to open a branch to be located at 10195 Berry Road, Waldorf, Maryland. This "express" branch opened August 31, 1999 as part of a mini-mart on a key homeward bound commuter route in Charles County. All bank services are offered at this location. Also in 1999, the Bank received regulatory approval to purchase a non- controlling interest in Maryland Title Center West, L.L.C. (the "LLC"). The LLC is a Maryland limited liability company which acts as a title insurance agent. The LLC is jointly owned by several national and state banks located in the State of Maryland. The Bank invested in the LLC in June 1999. When possible, the Bank will process loan settlements utilizing the LLC rather than the independent agents used in prior years. 1 Financial Modernization Legislation On November 12, 1999, President Clinton signed legislation which could have a far-reaching impact on the financial services industry. The Gramm-Leach- Bliley ("G-L-B") Act authorizes affiliations between banking, securities and insurance firms and authorizes bank holding companies and national banks to engage in a variety of new financial activities. Among the new activities that will be permitted to bank holding companies are securities and insurance brokerage, securities underwriting, insurance underwriting and merchant banking. The Board of Governors of the Federal Reserve System (the "Federal Reserve Board"), in consultation with the Secretary of the Treasury, may approve additional financial activities. The G-L-B Act imposes new requirements on financial institutions with respect to customer privacy. The G-L-B Act generally prohibits disclosure of customer information to non-affiliated third parties unless the customer has been given the opportunity to object and has not objected to such disclosure. Financial institutions are further required to disclose their privacy policies to customers annually. Financial institutions, however, will be required to comply with state law if it is more protective of customer privacy than the G-L- B Act. The G-L-B Act directs the federal banking agencies, the National Credit Union Administration, the Secretary of the Treasury, the Securities and Exchange Commission and the Federal Trade Commission, after consultation with the National Association of Insurance Commissioners, to promulgate implementing regulations within six months of enactment. The privacy provisions will become effective six months thereafter. The G-L-B Act contains a variety of other provisions including a prohibition against ATM surcharges unless the customer has first been provided notice of the imposition and amount of the fee. The G-L-B Act reduces the frequency of Community Reinvestment Act examinations for smaller institutions and imposes certain reporting requirements on depository institutions that make payments to non-governmental entities in connection with the Community Reinvestment Act. The G-L-B Act empowers the FHLB system to expand collateral eligibility to member banks under $500 million in asset size. This provision should allow the Bank to pledge certain small business assets, as well as its residential loan assets, as collateral for its funding. As the Bank evolves its lending strategy, the new provision will assist in funding the underlying assets. While the G-L-B Act is expected to facilitate affiliations with companies in the financial services industry, the Company is unable to predict the impact of the G-L-B Act on its operations at this time. Lending and Investment Activities General. The principal lending activity of the Bank has been the origination of single family conventional mortgage loans (i.e., loans that are ---- neither insured nor partially guaranteed by government agencies). To a lesser extent, the Bank also makes second mortgage loans, home equity loans, construction loans, and loans secured by multi-family dwellings. Since its conversion to a commercial bank, the Bank has put more emphasis on attracting and servicing consumer and commercial customers. Its long term strategy is to focus on this type of lending while maintaining its residential lending activity. The Bank offers real estate loans with both fixed and adjustable rates. The Bank's fixed-rate real estate loans may be packaged for resale in the secondary market or securitized for outside borrowings. The Bank has also purchased mortgage-backed securities. Geographic Lending Area. The Bank is authorized to make real estate loans throughout the United States, provided the Bank continues to meet the provisions of the Community Reinvestment Act to serve the communities in which it operates offices. The Bank's lending area consists of Charles, Calvert and St. Mary's counties in Maryland. 2 Residential Real Estate Loans. The primary lending activity of the Bank is the granting of conventional loans to enable borrowers to purchase existing homes. At December 31, 1999, approximately 67% of the Bank's total loan portfolio consisted of loans secured by residential real estate, including residential apartment buildings. Mortgage loans made by the Bank are generally long-term loans, amortized on a monthly basis, with principal and interest due each month. The initial contractual loan payment period for residential loans typically ranges from 10 to 30 years. The Bank's experience indicates that real estate loans remain outstanding for significantly shorter periods than their contractual terms. Borrowers may refinance or prepay loans at their option. The Bank aggressively markets adjustable-rate loans with rate adjustments based upon a United States Treasury bill index. As of December 31, 1999, the Bank had $29.6 million in loans using a U.S. Treasury bill index. The Bank offers mortgages which are adjustable on a one, a three and a five year basis with limitations on upward adjustments of 2% per year and 6% over the life of the loan. The Bank also offers long term fixed rate loans. The fixed rate loans may be packaged and sold in the secondary market, primarily to the Federal Home Loan Mortgage Corporation ("FHLMC"), private mortgage correspondents, the Federal National Mortgage Association ("FNMA") and the Mortgage Partnership Finance program of the FHLB, or are exchanged for FHLMC participation certificates or FNMA mortgage-backed securities. The retention of adjustable-rate mortgage loans in the Bank's loan portfolio helps reduce the Bank's exposure to increases in interest rates. However, there are unquantifiable credit risks resulting from potential increased costs to the borrower as a result of repricing of adjustable-rate mortgage loans. It is possible that during periods of rising interest rates, the risk of default on adjustable-rate mortgage loans may increase due to the upward adjustment of interest cost to the borrower. The Bank makes loans up to 95% of appraised value or sales price of the property, whichever is less, to qualified owner occupants upon the security of single family homes. Non-owner occupied one- to four-family loans and loans secured by other than residential real estate are generally permitted to a maximum 70% loan-to-value of the appraised value depending on the overall strength of the application. The Bank currently requires that substantially all residential loans with loan to value ratios in excess of 80% carry private mortgage insurance to bring the Bank's exposure down to approximately 70% of the value of the property. All improved real estate which serves as security for a loan made by the Bank must be insured, in the amount and by such companies as may be approved by the Bank, against fire, vandalism, malicious mischief and other hazards. Such insurance must be maintained through the entire term of the loan and in an amount not less than that amount necessary to pay the Bank's indebtedness in full. The Bank has maintained a growing level of home equity loans in recent years. These loans, which totaled $16.7 million at December 31, 1999, are generally made in minimum amounts of $5,000, have terms of up to 20 years, variable rates priced at prime or some margin above prime and require an 80% or 90% loan-to-value ratio, depending on the specific loan program. Commercial Real Estate and Other Non-Residential Real Estate Loans. The Bank has increased emphasis to loans for the construction and permanent financing of commercial and other improved real estate projects, including, to a limited extent, office buildings, as well as churches and other special purpose projects. As a result, commercial real estate loans increased $10.2 million or 52% during 1999. The primary security on a commercial real estate loan is the real property and the leases which produce income for the real property. Commercial real estate loans amounted to approximately $29.9 million or 20% of the Bank's loan portfolio at December 31, 1999. The Bank generally limits its exposure to a single borrower to 15% of the Bank's net worth and frequently participates with other lenders on larger projects. Loans secured by commercial real estate are generally limited to 75% of appraised value and generally have an initial contractual loan payment period ranging from three to 20 years. Virtually all of the 3 Bank's commercial real estate loans, as well as its construction loans discussed below, are secured by real estate located in the Bank's primary market area. Loans secured by commercial real estate are larger and involve greater risks than one- to four-family residential mortgage loans. Because payments on loans secured by such properties are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to a greater extent to adverse conditions in the real estate market or the economy. The Bank restricts its commercial real estate lending primarily to owner occupied buildings which will, to some extent, be occupied by the borrower as opposed to speculative rental projects. As a result of the greater emphasis that the Bank places on commercial real estate loans under its business plan as a commercial bank, the Bank is increasingly exposed to the risks posed by this type of lending. Construction Loans. The Bank offers construction loans to individuals and building contractors primarily for the construction of one- to four-family dwellings. These loans have constituted a significant portion of the Bank's loan originations in recent years. Most of these loans are construction/permanent loans which have fixed rates, payable monthly for the construction period and are followed by a 30 year fixed or adjustable rate permanent loan. Most construction loans provide for disbursement of loan funds based on draw requests submitted by the builder during construction and site inspections by independent inspectors. The Bank will also make a construction loan if the borrower has a commitment from another lender for a permanent loan at the completion of the construction. These loans typically have terms of six months. The application process includes the same items which are required for other mortgage loans and also requires the borrower to submit to the Bank accurate plans, specifications, and costs of the property to be constructed. These items are used as a basis to determine the appraised value of the subject property. Construction loans totaled $17.1 million, or 12% of the Bank's loan portfolio, at December 31, 1999. Construction financing involves a higher degree of risk than long-term financing on improved, occupied real estate. The Bank's risk of loss on a construction loan is dependent primarily upon the accuracy of the initial estimate of the property's value at completion of construction or development and the estimated cost, including interest, of completion. If the estimate of construction costs proves to be inaccurate, the Bank may be required to advance funds beyond the amount originally committed to permit completion of the project. If the estimate of value proves to be inaccurate, the project may have a value which is insufficient to assure full repayment of the loan. The Bank also offers builders lines of credit, which are revolving notes generally secured by real property. Outstanding builders lines of credit amounted to approximately $4.4 million at December 31, 1999. The Bank offers a builder's master note program in which the builder receives a revolving line of credit at a market rate and the Bank obtains security in the form of a first lien on home sites under construction. At December 31, 1999, $3.5 million in such loans were outstanding. In addition, the Bank offers loans for the purpose of acquisition and development of land, as well as loans on undeveloped, subdivided lots for home building by individuals. Land acquisition and development loans, included in construction loans discussed above, totaled $6.8 million at December 31, 1999. The Bank originated approximately $1.0 million of lot loans during 1999, which consisted of 15 loans secured by land in the Bank's market area, the largest of which had a balance of $350,000 at December 31, 1999. Land acquisition and development lending generally involves a higher degree of credit risk than lending on existing residential properties due to the concentration of principal in a limited number of loans and borrowers and the effects of general economic conditions on development projects. The Bank's ability to originate all types of construction loans is heavily dependent on the continued demand for single family housing construction in the Bank's market areas. In the event the demand for new houses in the Bank's market areas were to decline, the Bank may be forced to shift a portion of its lending emphasis. There can 4 be no assurance of the Bank's ability to continue growth and profitability in its construction lending activities in the event of such a decline. Consumer and Commercial Loans. The Bank has developed a number of programs to serve the needs of its customers with primary emphasis upon loans secured by automobiles, boats, recreational vehicles and trucks and heavy equipment. The Bank also makes home improvement loans and offers both secured and unsecured lines of credit. The Bank also offers a variety of commercial loan services including term loans, lines of credit and equipment financing. The Bank's commercial loans are primarily underwritten on the basis of the borrower's ability to service the debt from income. Such loans are generally made for terms of five years or less at interest rates which adjust periodically. The Bank believes that the shorter terms and the normally higher interest rates available on various types of consumer and commercial business loans have been helpful in maintaining a profitable spread between the Bank's average loan yield and its cost of funds. Consumer and commercial business loans do, however, entail greater risk than do residential mortgage loans, particularly in the case of consumer loans which are unsecured or secured by rapidly depreciable assets such as automobiles. In such cases, any repossessed collateral may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. The remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various Federal and state laws including Federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. Such loans may also give rise to claims and defenses by a consumer loan borrower against an assignee such as the Bank, and a borrower may be able to assert against such assignee claims and defenses which it has against the seller of the underlying collateral. Loan Portfolio Analysis. Set forth below is selected data relating to the composition of the Bank's loan portfolio by type of loan and type of security on the dates indicated. At December 31, -------------------------------------------------- 1999 1998 1997 1996 1995 -------- -------- -------- -------- -------- (In thousands) Type of Loan: Real Estate Loans -- Residential construction... $ 12,726 $ 16,147 $ 13,222 $ 7,946 $ 6,787 Mortgage................... 96,211 83,976 77,261 77,845 78,729 Builders Line of Credit.... 4,416 4,629 5,054 3,810 3,191 Home Equity................ 16,691 16,314 17,428 14,147 12,155 Commercial Lines of Credit.. 10,025 6,161 4,852 3,887 3,389 Consumer Loans.............. 9,102 7,889 6,420 5,422 4,841 Less: Deferred Loan Fees.. 808 930 1,060 1,086 1,172 Loan Loss Reserve... 1,653 1,540 1,310 1,120 733 -------- -------- -------- -------- -------- Total..................... $146,710 $132,646 $121,867 $110,851 $107,187 ======== ======== ======== ======== ======== Loan Solicitation and Processing. The Bank actively solicits mortgage loan applications from existing customers, local real estate agents, business entities, contractors and real estate developers. In addition, the Bank has several commissioned loan officers who originate loans with laptop computers to produce additional loan volume. Loan processing is centralized at the Bank's main office. Upon receipt of a loan application from a prospective borrower, a credit report and verifications are ordered to verify specific information relating to the loan applicant's 5 employment, income and credit standing. An appraisal of the real estate intended to secure the proposed loan is undertaken by a staff or an independent fee appraiser. The Bank uses FHLMC's Prospector Software and Purchase program. This provides the Bank with faster loan approval turnaround and competitive pricing of loans. The Bank's President has the authority to approve loans in amounts up to $750,000. The Bank's Senior Vice Presidents individually have the authority to approve loans in amounts up to $400,000. The Business Development Officer has loan authority of $150,000. Any two of the aforementioned individuals may combine their limits to approve a loan up to $1,000,000. The residential loan underwriter has authority to approve FHLMC and FNMA conforming loans up to the limits established from time to time by those organizations, currently $252,700. Selected branch personnel have authority to approve secured loans up to $75,000 and unsecured up to $50,000. A loan committee, consisting of the President and two members of the Board of Directors on a rotating basis, ratify all real estate mortgage loans and all other large (in excess of $100,000) loans. Loan applicants are promptly notified of the decision of the Bank by a letter setting forth the terms and conditions of the decision. If approved, these terms and conditions include the amount of the loan, interest rate, amortization term, a brief description of real estate to be mortgaged to the Bank, and the notice of requirement of insurance coverage to be maintained to protect the Bank's interest. Title insurance is required on all loans except second mortgages and home equity loans. Hazard insurance policies are required on all loans in an amount equal to the lesser of the loan balance or the replacement value of the structure. Loan Originations, Purchases and Sales. The Bank actively originates mortgage loans primarily for its own portfolio, and, periodically, for sale in the secondary mortgage market. At December 31, 1999, the Bank was servicing approximately $62 million of loans for others. Fee income from loan servicing totaled approximately $217,500 during 1999. The Bank has periodically purchased whole loans, participation interests in loans and participation certificates. In recent years, the Bank has participated in several residential home construction loans with other well capitalized lenders. Approximately $1.9 million of such loans was outstanding at December 31, 1999. These participation loans are for the acquisition and development of residential properties located in Maryland and the construction of housing stock on a pre sold basis. These loans have competitively priced terms and various maturity structures. Year Ended December 31, --------------------------- 1999 1998 1997 ------- -------- -------- (In thousands) Loans originated: Real estate loans: Construction loans.......... $ 9,665 $14,775 $17,549 Loans on existing property.. 8,416 10,502 11,542 Loans refinanced............ 8,418 12,780 4,081 Land loans.................. 4,201 4,061 1,337 Builder lines of credit..... 20,879 20,195 19,691 Commercial mortgage loans... 4,917 1,585 2,898 Commercial lines of credit..... 9,383 8,171 4,357 Consumer loans................. 5,877 5,756 4,234 ------- ------- ------- Total loans originated.... $71,756 $77,825 $65,689 ======= ======= ======= Loans sold: Participation loans......... $ 1,600 $ -- $ -- Whole loans................. 10,775 23,173 11,876 ------- ------- ------- Total loans sold.......... $82,531 $23,173 $11,876 ======= ======= ======= 6 The Bank occasionally packages some fixed rate loans it originates into mortgage participation certificates or direct sales utilizing the FHLMC, FNMA and private mortgage correspondents as its secondary market buyer. During 1999, the Bank sold $10.8 million of loans under direct sales agreements. For further information, see "Management's Discussion and Analysis" in the Annual Report. Loan Commitments. The Bank does not normally negotiate standby commitments for the construction and purchase of real estate. Conventional loan commitments are granted for a one month period. The total amount of the Bank's outstanding commitments to originate real estate loans at December 31, 1999, was approximately $359,000 million, excluding undisbursed portions of loans in process. It has been the Bank's experience that few commitments expire unfunded. Maturity of Loan Portfolio. The following table sets forth certain information at December 31, 1999 regarding the dollar amount of loans maturing in the Bank's portfolio based on their contractual terms to maturity. Demand loans (loans having no stated schedule of repayments and no stated maturity) and home equity loans which reprice within one year are reported as due in one year or less. Due after Due more Due within 1 through 5 than 5 1 year after years from years from December 31, December 31, December 31, 1999 1999 1999 Total ------------ ------------- ----------- -------- (In thousands) Mortgage ................... $ 6,570 $ 55,139 $ 32,286 $ 93,995 Residential construction ... 12,780 -- -- 12,780 Builder line of credit ..... 4,416 -- -- 4,416 Commercial line of credit .. 9,846 -- -- 9,846 Home equity ................ 13,352 713 2,626 16,691 Consumer ................... 227 7,114 1,640 8,982 -------- -------- -------- -------- $ 47,191 $ 62,966 $ 36,552 $146,710 ======== ======== ======== ======== The next table sets forth the dollar amount of all loans due after one year from December 31, 1999 which have predetermined interest rates and have floating or adjustable interest rates. Floating or Fixed Rates Adjustable Rates Total ----------- ---------------- ------- (In thousands) Mortgage ................. $40,857 $46,568 $87,425 Home equity .............. 3,339 -- 3,339 Consumer ................. 8,755 -- 8,755 ------- ------- ------- $52,951 $46,568 $99,519 ======= ======= ======= Loan Origination Fees. In addition to interest earned on loans, the Bank receives loan origination fees and discounts for originating loans which are computed as a percentage of the principal amount of the mortgage loan and are charged to the borrower for creation of the loan. 7 The Bank's loan origination fees and discounts are generally 1% to 2% on conventional residential mortgages and 1% or less for commercial real estate loans. Loan origination and loan commitment fees are volatile sources of income. Such fees vary with the volume and type of loans and commitments made and purchased and with competitive conditions in mortgage markets which, in turn, tend to vary in response to the demand and availability of money. The Bank has experienced a decrease in loan fee income during periods of unusually high interest rates due to the resulting lack of demand for mortgage loans. The Bank receives other fees and charges relating to existing loans, late charges, and fees collected in connection with a change in borrower or other loan modifications. These fees and charges have not constituted a material source of income for the Bank. Delinquencies. The Bank's collection procedures provide that when a loan is 15 days delinquent, the borrower is contacted by mail and payment is requested. If the delinquency continues, subsequent efforts will be made to contact the delinquent borrower. In certain instances, the Bank will modify the loan or grant a limited moratorium on loan pay ments to enable the borrower to reorganize his financial affairs. If the loan continues in a delinquent status for 90 days or more, the Bank will generally initiate foreclosure proceedings. Non-Performing Assets and Asset Classification. Loans are reviewed on a regular basis and are placed on a non-accrual status when, in the opinion of management, the collection of additional interest is doubtful. Residential mortgage loans are placed on non-accrual status when either principal or interest is 90 days or more past due unless they are adequately secured and there is reasonable assurance of full collection of principal and interest. Consumer loans generally are charged off when the loan becomes over 120 days delinquent. Commercial business and real estate loans are placed on non-accrual status when the loan is 90 days or more past due. Interest accrued and unpaid at the time a loan is placed on non-accrual status is charged against interest income. Subsequent payments are either applied to the outstanding principal balance or recorded as interest income, depending on the assessment of the ultimate collectibility of the loan. Real estate acquired by the Bank as a result of foreclosure or by deed in lieu of foreclosure is classified as foreclosed real estate until such time as it is sold. When such property is acquired, it is recorded at its fair market value. Subsequent to foreclosure, the property is carried at the lower of cost or fair value less selling costs. Any write-down of the property at foreclosure is charged to the allowance for loan losses. The Bank had foreclosed real estate with a fair market value of approximately $176,000 at December 31, 1999. 8 The following table sets forth information with respect to the Bank's non- performing assets for the periods indicated. During the periods shown, the Bank had no impaired loans within the meaning of Statement of Financial Accounting Standards No. 114 and 118. At December 31, -------------------------------------- 1999 1998 1997 1996 1995 ------ ------ ------ ------ ------ (In thousands) Accruing loans which are contractually past due 90 days or more: Real Estate: Residential...........................$ 171 $ 196 $ 165 $ 262 $ 226 Commercial............................ -- -- -- -- -- Commercial Business.................... -- -- -- -- -- Consumer............................... -- -- -- 79 -- ----- ----- ----- ----- ----- Total................................$ 171 $ 196 $ 165 $ 341 $ 226 ===== ===== ===== ===== ===== Percentage of Total Loans................ .12% .15% .14% .32% .21% ===== ===== ===== ===== ===== Loans accounted for on a nonaccrual basis: (1) Real Estate: Residential...........................$ 20 $ 126 $ 34 $ 358 $ 323 Commercial Business................... -- 85 30 -- -- Consumer.............................. 198 58 95 -- 17 ----- ----- ----- ----- ----- Total................................ 218 269 159 358 340 ----- ----- ----- ----- ----- Total nonperforming loans................$ 389 $ 465 $ 324 $ 699 $ 566 ===== ===== ===== ===== ===== - ---------------- (1) Nonaccrual status denotes loans on which, in the opinion of management, the collection of additional interest is unlikely, or loans that meet nonaccrual criteria as established by regulatory authorities. During the fiscal year ended December 31, 1999, gross interest income of $27,000 would have been recorded on loans accounted for on a non-accrual basis if the loans had been current throughout the period. No interest on such loans was included in income during 1999. 9 The following table sets forth an analysis of the Bank's allowance for possible loan losses for the periods indicated. Year Ended December 31, ----------------------------------------- 1999 1998 1997 1996 1995 ------ ------- ------- ------- ------ (In thousands) Balance at Beginning of Period....... $1,540 $1,310 $1,120 $ 734 $ 564 ------ ------ ------ ------ ----- Loans Charged-Off: Real Estate: Residential........................ -- -- 11 17 34 Commercial......................... -- -- -- -- -- Commercial Business................. 102 -- 21 -- -- Consumer............................ 32 10 18 5 12 ------ ------ ------ ------ ----- Total Charge-Offs.................... 134 10 50 22 46 ------ ------ ------ ------ ----- Recoveries: Residential Real Estate............ -- -- -- -- 2 Consumer Loans..................... 7 -- -- -- 4 ------ ------ ------ ------ ----- Total Recoveries..................... 7 -- -- -- 6 Provision for Possible Loan Losses.. 240 240 240 408 210 ------ ------ ------ ------ ----- Balance at End of Period............. $1,653 $1,540 $1,310 $1,120 $ 734 ====== ====== ====== ====== ===== Ratio of Net Charge-Offs to Average Loans Outstanding During the Period......................... .09% .01% .04% .02% .04% ====== ====== ====== ====== ===== 10 The following table allocates the allowance for loan losses by loan category at the dates indicated. The allocation of the allowance to each category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any category.
At December 31, ---------------------------------------------------------------------------------------- 1999 1998 1997 ---------------------------- --------------------------- ----------------------------- Percent of Percent of Percent of Loans in Each Loans in Each Loans in Each Category to Category to Category to Amount Total Loans Amount Total Loans Amount Total Loans ------------- -------------- ------------- ------------- ----------- -------------- (Dollars in thousands) Real Estate: Residential....................... $ 955 67.0% $1,029 74.9% $ 881 75.7% Commercial and other.............. 399 20.2 281 14.6 255 15.2 Commercial and unsecured........... 178 6.7 117 4.6 87 5.2 Consumer........................... 121 6.1 113 5.9 87 3.9 ------ ----- ------ ----- ------ ----- Total allowance for loan losses.. $1,653 100.0% $1,540 100.0% $1,310 100.0% ====== ===== ====== ===== ====== ===== At December 31, ---------------------------------------------------------- 1996 1995 ---------------------------- --------------------------- Percent of Percent of Loans in Each Loans in Each Category to Category to Amount Total Loans Amount Total Loans ------------- -------------- ------------- ------------- (Dollars in thousands) Real Estate: Residential....................... $ 786 79.3% $ 694 81.1% Commercial and other.............. 240 12.5 -- 11.4 Commercial and unsecured........... 41 3.4 -- 3.1 Consumer........................... 53 4.8 40 4.4 ------ ----- ------ ----- Total allowance for loan losses.. $1,120 100.0% $ 734 100.0% ====== ===== ====== =====
11 The Bank closely monitors the loan payment activity of all its loans. Any consumer loan which is determined to be uncollectible is charged off against the allowance for loan losses. A loan loss provision is provided by a monthly accrual based on analysis of the loan portfolio characteristics and industry norms. The allowance for loan losses was approximately 1% of outstanding loan balances. This measure was deemed prudent to achieve a sufficient reserve level commensurate with the Bank's portfolio risk. While the Bank believes it has established its existing allowances for loan losses in accordance with generally accepted accounting principles, there can be no assurance that regulators, in reviewing the Bank's loan portfolio, will not request the Bank to significantly increase its allowance for loan losses, thereby negatively affecting the Bank's financial condition and earnings. Investment Activities Interest income from cash deposits and investment securities generally provides the second largest source of income for the Bank after interest payments on loans. At December 31, 1999, the Bank's interest-bearing cash and investment securities portfolio of $64 million consisted of deposits in other financial institutions, corporate equity securities, money market funds, obligations of U.S. Government Corporations and agencies and asset-backed securities. The Bank is in compliance with applicable liquidity requirements. The Bank is required under Maryland regulations to maintain a minimum amount of liquid assets sufficient to meet the operating needs of the Bank and its customers. These assets may be invested in interest and noninterest-bearing cash and certain other investments. See "Regulation -- Liquidity Requirements" below and "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity" in the Annual Report. It has been the Bank's policy in the past to maintain a liquidity portfolio that met regulatory requirements, and at December 31, 1999, the Bank's liquidity was in compliance with Maryland requirements. Investment decisions are made by authorized officers of the Bank under the supervision of the Bank's Board of Directors. Brokers periodically approved by the Board of Directors are used to effect securities transactions. See Notes 2 and 3 of Notes to Consolidated Financial Statements in the Annual Report. The following table sets forth the carrying value of the Corporation's investment securities portfolio and Federal Home Loan Bank ("FHLB") and Federal Reserve Bank stock at the dates indicated. At December 31, 1999, their market value was $60.9 million. At December 31, -------------------------- 1999 1998 1997 ------- ------- -------- (In thousands) Investment securities: Asset-backed securities...................... $47,465 $45,964 $44,035 Money market funds........................... 820 293 4,011 FHLMC, FNMA, SLMA and FHLB notes............. 7,619 9,045 5,003 Federal Home Loan Bank of Atlanta, Federal Reserve, Federal Home Loan Mortgage Corporation and Federal National Mortgage Corporation Stock.......................... 3,039 3,226 2,229 Treasury bills............................... 198 196 192 Other investments............................ 1,749 1,397 281 ------- ------- ------- Total investment securities and FHLB and Federal Reserve Bank stock.............. $60,890 $60,121 $55,752 ======= ======= ======= 12 The maturities and weighted average yields for investment securities available for sale and held to maturity at December 31, 1999 are shown below.
After One After Five One Year or Less Through Five Years Through Ten Years After Ten Years ----------------------------- ---------------------------- --------------------- ------------------ Carrying Average Carrying Average Carrying Average Carrying Average Value Yield Value Yield Value Yield Value Yield -------------- ------------- ------------- ------------- -------- ----------- -------- -------- (Dollars in thousands) Investment securities available for sale: Corporate equity securities ................... $ 751 3.84% $ -- --% $ -- --% $ -- --% Asset-backed securities ....... -- -- -- -- 9,028 6.77 38,437 6.95 Money market funds ............ 820 6.45 -- -- -- -- -- -- Obligations of U.S. ........... government sponsored enterprises (GSE) ............ -- -- 988 6.48 6,631 7.02 -- -- ------- ------ ------ ------ Total investment securities available for sale ....... $ 1,571 5.20 $ 988 6.48 $15,659 6.88 $38,437 6.95 ======= ======= ======= ====== Investment securities held-to-maturity: Asset-backed securities ....... $ -- -- $ -- -- $ -- -- $ -- -- Treasury bills ................ -- -- 198 4.45 -- -- -- -- Other investments ............. 1,749 6.48 -- -- -- -- -- -- ------- ------- --------- ------- ------- ----- ------- ----- Total investment securities held-to-maturity ......... $ 1,749 $ 198 $ -- $ -- ======= ======== ======= =======
13 The Bank's investment policy provides that securities that will be held for indefinite periods of time, including securities that will be used as part of the Bank's asset/liability management strategy and that may be sold in response to changes in interest rates, prepayments and similar factors, are classified as available for sale and accounted for at the fair value. Management's intent is to hold securities reported at amortized cost to maturity. For further information regarding the Corporation's investment securities, see Notes 2 and 3 of Notes to Consolidated Financial Statements in the Annual Report. Savings Activities and Other Sources of Funds General. Deposits are the major source of the Bank's funds for lending and other investment purposes. In addition to deposits, the Bank derives funds from loan principal repayments, advances from the FHLB of Atlanta and other borrowings. Loan repayments are a relatively stable source of funds, while deposit inflows are significantly influenced by general interest rates and money market conditions. Borrowings may be used on a short term basis to compensate for reductions in the availability of other sources of funds. They may also be used on a longer term basis for general business purposes. Deposits. Deposits are solicited throughout the Bank's market area through the Bank's branch system. The Bank offers a wide variety of deposit accounts with terms that vary, with the principal differences being the minimum balance required, the time periods the funds must remain on deposit and the interest rate. To date, the Bank has not obtained any funds through brokers. In recent years, the Bank has relied increasingly on newly authorized types of short-term accounts and other savings alternatives that are responsive to changes in market rates of interest. Advances. With its membership in the FHLB, the Bank utilizes wholesale borrowings to fund its lending activity. In addition, to prudently leverage its net worth, the Bank purchases certain authorized investments using borrowings from the FHLB for a managed spread. The following table indicates the amount of the Bank's certificates of deposit and other time deposits of more than $100,000 by time remaining until maturity as of December 31, 1999. Certificates Maturity Period of Deposit ------------------ -------------- (In thousands) One through three months... $ 501 Three through six months... 1,799 Six through twelve months.. 2,651 Over twelve months......... 6,683 ------- Total.................. $11,634 ======= 14 Borrowings. Savings deposits are the primary source of funds for the Bank's lending and investment activities and for its general business purposes. The Bank does, however, rely upon advances from the FHLB of Atlanta to supplement its supply of lendable funds and to meet deposit withdrawal requirements. The FHLB of Atlanta has served as the Bank's primary borrowing source. Advances from the FHLB are typically secured by the Bank's stock in the FHLB, a portion of the Bank's residential mortgage loans and its eligible investments. At December 31, 1999, advances from the FHLB of Atlanta were as follows: At or for the Year Ended December 31, ------------------------------ 1999 1998 1997 -------- -------- ---------- (Dollars in thousands) Long-term amounts outstanding at end of period: FHLB advances.................................. $31,400 $16,400 $16,400 Other borrowings............................... -- 96 279 Weighted average rate on outstanding long-term: FHLB advances.................................. 5.54% 5.64% 5.91% Other borrowings............................... -- 8.50 8.50 Maximum amount of long-term borrowings outstanding at any month end: FHLB advances.................................. $31,400 $16,400 $16,400 Other borrowings............................... 37 207 427 Short-term borrowings outstanding with respect to: FHLB advances.................................. $13,000 $16,500 $12,000 Other borrowings............................... 398 437 523 Approximate weighted average rate paid on short-term: (1) FHLB advances.................................. 5.57% 5.76% 5.80% Other borrowings............................... 4.42 5.37 4.65 - ------------------------- (1) Based on month-end balances. The FHLB of Atlanta functions as a central reserve bank providing credit for member institutions. As a member, the Bank is required to own capital stock in the FHLB and is authorized to apply for advances on the security of such stock and certain of its home mortgages and other assets (principally, securities which are obligations of, or guaranteed by, the United States government) provided certain standards related to creditworthiness have been met. Advances are made pursuant to several different programs. Each credit program has its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of an association's net worth or on the FHLB's assessment of the association's creditworthiness. Under its current credit policies, the FHLB limits advances to 30% of a member's assets, but there are no other limitations on the amount of advances which may be made to an association. The Bank, through a finance subsidiary, has also borrowed funds through a collateralized mortgage obligation program. For further information, see Note 7 of Notes to Consolidated Financial Statements. For more information regarding the Bank's borrowings, see Note 7 of Notes to Consolidated Financial Statements. Yields Earned and Rates Paid The pre-tax earnings of the Bank depend significantly upon the spread between the income it receives from its loan and investment portfolios and its cost of money, consisting of the interest paid on deposit accounts and borrowings. 15 The following table sets forth for the periods and at the dates indicated, the weighted average yields earned on the Bank's assets, the weighted average interest rates paid on the Bank's liabilities, together with the interest rate spread and net yield on interest-earning assets. At Years Ended December 31, December 31, ---------------------------- 1999 1999 1998 1997 ----------- ------ ----- ----- Weighted average yield on loan portfolio ................... 8.05% 8.37% 9.00% 9.18% Weighted average yield on interest-bearing cash and investment securities portfolio ... 7.70 6.46 6.42 6.48 Weighted average yield on all interest-earning assets ... 7.94 7.75 8.15 8.27 Weighted average rate paid on savings deposits and escrow ....... 3.68 3.59 3.91 4.06 Weighted average rate paid on Federal Home Loan Bank advances and other borrowings .............. 5.64 5.33 5.72 5.91 Weighted average rate paid on all interest-bearing liabilities 4.10 3.92 4.24 4.37 Interest rate spread (spread between weighted average rate on all interest-earning assets and all interest-bearing liabilities) ..... 3.84 3.83 3.91 3.90 Net yield (net interest income as a percentage of average interest-earning assets) .......... 4.04 4.11 4.21 4.21 16 Average Balance Sheet The following table presents for the periods indicated the Bank's average balance sheet and reflects the amount of interest income from average interest- earning assets and the resultant yields, as well as the amount of interest expense on average interest-bearing liabilities and the resultant costs, expressed both in dollars and rates. Interest income includes fees which are considered adjustments to yields. Average balances are based on average month- end balances.
For the Year Ended December 31, ------------------------------------------------------------------ At December 31, 1999 1999 1998 --------------------- ------------------------------- ------------------------------ Average Average Average Yield/ Average Yield/ Average Yield/ Balance Cost Balance Interest Cost Balance Interest Cost ------- -------- ------- -------- -------- -------- -------- -------- (Dollars in thousands) Interest-earning assets: Loan portfolio ........ $147,483 8.05% $138,140 $ 11,563 8.37% $129,375 $ 11,638 9.00% Cash and investment securities ........... 63,953 7.70 66,379 4,290 6.46 63,609 4,084 6.42 -------- ---- -------- -------- ---- -------- -------- ---- Total interest-earning assets ............ 211,436 7.94 204,519 15,853 7.75 192,984 15,722 8.15 -------- ---- -------- -------- ---- -------- -------- ---- Interest-bearing liabilities: Savings deposits and escrow ............... $155,742 3.68% $154,699 $ 5,529 3.59% $145,752 $ 5,694 3.91% FHLB advances and other borrowings ........... 44,798 5.64 35,859 1,912 5.33 33,294 1,903 5.72 ---- -------- -------- ---- -------- -------- ---- Total interest- bearing liabilities $201,540 4.16% $190,558 7,441 3.92 $179,046 7,597 4.24 ======== ---- ======== ======== Net interest income........ $ 8,412 $ 8,125 ======= ======= Interest rate spread....... 3.84% 3.83% 3.91% ==== ==== ==== Net yield on interest-earning assets... 4.04% 4.11% 4.21% ==== ==== ==== Ratio of average interest-earning assets to average interest-bearing liabilities............. 104.9% 105.1% 107.8% ===== ===== ===== 1997 --------------------------- Average Average Yield/ Balance Interest Cost -------- -------- -------- Interest-earning assets: Loan portfolio ........ $120,178 $ 11,029 9.18% Cash and investment securities ........... 60,716 3,937 6.48 -------- -------- ---- Total interest-earning assets ............ 180,894 14,966 8.27 -------- -------- ---- Interest-bearing liabilities: Savings deposits and escrow ............... $139,941 $ 5,683 4.06% FHLB advances and other borrowings ........... 28,184 1,667 5.91 -------- -------- ---- Total .............. $168,125 7,350 4.37% ======== -------- ---- Net interest income........ $ 7,616 ======= Interest rate spread....... 3.90% ==== Net yield on interest-earning assets... 4.21% ==== Ratio of average interest-earning assets to average interest-bearing liabilities............. 107.6% =====
17 Rate/Volume Analysis The table below sets forth certain information regarding changes in interest income and interest expense of the Bank for the periods indicated. For each category of interest-earning asset and interest-bearing liability, information is provided on changes attributable to (1) changes in volume (changes in volume multiplied by old rate); (2) changes in rate (changes in rate multiplied by old volume); (3) changes in rate-volume (changes in rate multiplied by the change in volume).
Year Ended December 31, ------------------------------------------------------------------- 1998 vs. 1999 1997 vs. 1998 -------------------------------- --------------------------------- Increase (Decrease) Increase (Decrease) Due to Due to -------------------------------- --------------------------------- Rate/ Rate/ Volume Rate Volume Total Volume Rate Volume Total ------ ------- ------- ------ ------ -------- ------- ------ (In thousands) Interest income: Loan portfolio................... $ 789 $(809) $ (55) $ (75) $ 844 $(218) $(18) $608 Interest-earning cash and investment portfolio........... 180 25 1 206 185 (36) (2) 147 ----- ----- ----- ----- ------ ----- ---- ---- Total interest-earning assets....... $ 969 $(784) $ (54) $ 131 $1,029 $(254) $(20) $755 ----- ----- ----- ----- ------ ----- ---- ---- Interest expense: Savings deposits and escrow...... $ 350 $(486) $ (29) $(165) $ 229 $(210) $ (9) $ 10 FHLB advances and other borrowings..................... 147 (128) (10) 7 300 (54) (10) 236 ----- ----- ----- ----- ------ ----- ---- ---- Total interest-bearing liabilities.. $ 497 $(614) $ (39) $(156) $ 529 $(264) $(19) $246 ===== ===== ===== ===== ====== ===== ==== ====
Key Operating Ratios The table below sets forth certain performance ratios of the Corporation for the periods indicated. Year Ended December 31, -------------------------- 1999 1998 1997 -------- ------- ------- Return on Assets (Net Income Divided by Average Total Assets).. 1.00% 1.20% 1.13% Return on Equity (Net Income Divided by Average Equity)........ 10.23% 11.87% 11.53% Equity-to-Assets Ratio (Average Equity Divided by Average Total Assets)................................ 9.79% 10.10% 9.79% Subsidiary Activity In 1985, the Bank formed Tri-County Federal Bank Finance One as a finance subsidiary for the purpose of issuing a $6.5 million collateralized mortgage obligation. In June 1999, the obligation was satisfied, allowing the return of the participation certificates serving as collateral to the Bank and closing the subsidiary. In April 1997, the Bank formed a wholly owned subsidiary, Community Mortgage Corporation of Tri-County, to offer mortgage banking and brokerage services to the public. To date, this corporation has been inactive. In August 1999, the Bank 18 formed a wholly owned subsidiary, Tri-County Investment Corporation to hold and manage a portion of the Bank's investment portfolio in the State of Delaware. Depository Institution Regulation General. The Bank is a Maryland commercial bank and its deposit accounts are insured by the Savings Association Insurance Fund ("SAIF"). The Bank is a member of the Federal Reserve System. The Bank is subject to supervision, examination and regulation by the State of Maryland Commissioner of Financial Regulation ("Commissioner") and the Board of Governors of the Federal Reserve (the "FRB") and to Maryland and federal statutory and regulatory provisions governing such matters as capital standards, mergers and establishment of branch offices. The Bank is subject to the FDIC's authority to conduct special examinations. The Bank is required to file reports with the Commissioner and the FRB concerning its activities and financial condition and will be required to obtain regulatory approvals prior to entering into certain transactions, including mergers with, or acquisitions of, other depository institutions. As a federally insured depository institution, the Bank is subject to various regulations promulgated by the FRB, including Regulation B (Equal Credit Opportunity), Regulation D (Reserve Requirements), Regulation E (Electronic Fund Transfers), Regulation Z (Truth in Lending), Regulation CC (Availability of Funds and Collection of Checks) and Regulation DD (Truth in Savings). The system of regulation and supervision applicable to the Bank establishes a comprehensive framework for the operations of the Bank and is intended primarily for the protection of the FDIC and the depositors of the Bank. Changes in the regulatory framework could have a material effect on the Bank and its respective operations that in turn, could have a material effect on the Corporation. Liquidity Requirements. The Bank is subject to the reserve requirements imposed by the State of Maryland. A Maryland commercial bank is required to have at all times a reserve equal to at least 15% of its demand deposits. The board of directors of a Maryland commercial bank must by resolution direct the commercial bank to maintain this reserve ratio in: (i) cash on hand; (ii) demand deposits in a bank of good standing in any state; or (iii) as to 5% of its demand deposits, on approval of the Commissioner, (a) registered or coupon bonds, or (b) general obligations guaranteed by the United States government, an agency of the United States government, the State of Maryland, or any political subdivision. Additionally, a Maryland commercial bank must have at all times a reserve equal to at least 3% of all time deposits. Time deposit reserves must be kept in: (i) cash on hand; (ii) deposits in a bank of good standing in any state; or (iii) direct obligations of the United States government or of the State of Maryland. Under the Maryland statute, "demand deposits" are defined as deposits payable within 30 days and "time deposits" are defined to be deposits that are payable after 30 days, including a savings account or certificate of deposit that requires at least a 30-day notice before payment. As of December 31, 1999 the Bank was in compliance with Maryland's reserve requirements. Regulatory Capital Requirements. The Bank is subject to FRB capital requirements as well as statutory capital requirements imposed under Maryland law. FRB regulations establish two capital standards for state-chartered banks that are members of the Federal Reserve System ("state member banks"): a leverage requirement and a risk-based capital requirement. In addition, the Federal Reserve may on a case-by-case basis, establish individual minimum capital requirements for a bank that vary from the requirements which would otherwise apply under FRB regulations. A bank that fails to satisfy the capital requirements established under the FRB's regulations will be subject to such administrative action or sanctions as the FRB deems appropriate. The leverage ratio adopted by the FRB requires a minimum ratio of "Tier 1 capital" to adjusted total assets of 5% for banks rated composite 1 under the CAMELS rating system for banks. Banks not rated composite 1 under the CAMELS rating system for banks are required to maintain a minimum ratio of Tier 1 capital to adjusted total assets of 4% to 5%, depending upon the level and nature of risks of their operations. For purposes of the FRB's 19 leverage requirement, Tier 1 capital generally consists of common stockholders' equity (including retained earnings), noncumulative perpetual preferred stock and related surplus, minority interests in the equity accounts of fully consolidated subsidiaries, certain nonwithdrawable accounts and pledged deposits. The risk-based capital requirements established by the FRB's regulations require state member banks to maintain "total capital" equal to at least 8% of total risk-weighted assets. For purposes of the risk-based capital requirement, "total capital" means Tier 1 capital (as described above) plus "Tier 2 capital" defined to include certain preferred stock issues, nonwithdrawable accounts and pledged deposits that do not qualify as Tier 1 capital, certain approved subordinated debt, certain other capital instruments and a portion of the bank's general loss allowance. Total risk-weighted assets equal the sum of the amount of each asset and credit-equivalent amount of each off-balance sheet item after such asset or item is multiplied by an assigned risk weight. The FRB's regulations establish four risk weights, 0%, 20%, 50% and 100%. In addition, the Bank is subject to the statutory capital requirements imposed by the State of Maryland. Under Maryland statutory law, if the surplus of a Maryland commercial bank at any time is less than 100% of its capital stock, then, until the surplus is 100% of the capital stock, the commercial bank: (i) must transfer to its surplus annually at least 10% of its net earnings; and (ii) may not declare or pay any cash dividends that exceed 90% of its net earnings. Prompt Corrective Regulatory Action. Under requirements implementing the Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"), the federal banking regulators generally measure a depository institution's capital adequacy on the basis of the institution's total risk-based capital ratio (the ratio of its total capital to risk-weighted assets), Tier 1 risk-based capital ratio (the ratio of its core capital to risk-weighted assets) and leverage ratio (the ratio of its core capital to adjusted total assets). Under the regulations, an institution that is not subject to an order or written directive to meet or maintain a specific capital level will be deemed "well capitalized" if it also has: (i) a total risk-based capital ratio of 10% or greater; (ii) a Tier 1 risk-based capital ratio of 6.0% or greater; and (iii) a leverage ratio of 5.0% or greater. An "adequately capitalized" institution is an institution that does not meet the definition of well capitalized and has: (i) a total risk- based capital ratio of 8.0% or greater; (ii) a Tier 1 capital risk-based ratio of 4.0% or greater; and (iii) a leverage ratio of 4.0% or greater (or 3.0% or greater if the institution has a composite 1 CAMEL rating). An "undercapitalized institution" is an institution that has (i) a total risk-based capital ratio less than 8.0%; or (ii) a Tier 1 risk-based capital ratio of less than 4.0%; or (iii) a leverage ratio of less than 4.0% (or 3.0% if the association has a composite 1 CAMEL rating). A "significantly undercapitalized" institution is defined as an institution that has: (i) a total risk-based capital ratio of less than 6.0%; or (ii) a Tier 1 risk-based capital ratio of less than 3.0%; or (iii) a leverage ratio of less than 3.0%. A "critically undercapitalized" institution is defined as an institution that has a ratio of "tangible equity" to total assets of less than 2.0%. Tangible equity is defined as core capital plus cumulative perpetual preferred stock (and related surplus) less all intangibles other than qualifying supervisory goodwill and certain purchased mortgage servicing rights. The FRB may reclassify a well capitalized institution as adequately capitalized and may require an adequately capitalized or undercapitalized institution to comply with the supervisory actions applicable to institutions in the next lower capital category (but may not reclassify a significantly undercapitalized institution as critically under- capitalized) if the FRB determines, after notice and an opportunity for a hearing, that the institution is in an unsafe or unsound condition or that the institution has received and not corrected a less-than-satisfactory rating for any CAMEL rating category. At December 31, 1999, the Bank was classified as "well capitalized" under these regulations. Deposit Insurance. The Bank is required to pay assessments based on a percentage of its insured deposits to the FDIC for insurance of its deposits by the SAIF. Under the FDIC's risk-based deposit insurance assessment system, the assessment rate for an insured depository institution depends on the assessment risk classification assigned to the institution by the FDIC, which is determined by the institution's capital level and supervisory evaluations. Based on the data reported to regulators for the date closest to the last day of the seventh month preceding the semi-annual assessment period, institutions are assigned to one of three capital groups -- well capitalized, adequately 20 capitalized or undercapitalized -- using the same percentage criteria as in the prompt corrective action regulations. See " -- Prompt Corrective Action." Within each capital group, institutions are assigned to one of three subgroups on the basis of supervisory evaluations by the institution's primary supervisory authority and such other information as the FDIC determines to be relevant to the institution's financial condition and the risk posed to the deposit insurance fund. Subgroup A consists of financially sound institutions with only a few minor weaknesses. Subgroup B consists of institutions that demonstrate weaknesses which, if not corrected, could result in significant deterioration of the institution and increased risk of loss to the deposit insurance fund. Subgroup C consists of institutions that pose a substantial probability of loss to the deposit insurance fund unless effective corrective action is taken. The Bank is currently classified in Subgroup A under these regulations. Federal Reserve System. Pursuant to regulations of the FRB, all FDIC- insured depository institutions must maintain average daily reserves against their transaction accounts. Because required reserves must be maintained in the form of vault cash or in a noninterest bearing account at a Federal Reserve Bank, the effect of the reserve requirement is to reduce the amount of the institution's interest-earning assets. At December 31, 1999, the Bank met its reserve requirements. The Bank is a member of the Federal Reserve System and has subscribed for stock in the Federal Reserve Bank of Richmond in an amount equal to 6% of the Bank's common stock and surplus. The monetary policies and regulations of the FRB have a significant effect on the operating results of commercial banks. The FRB's policies affect the levels of bank loans, investments and deposits through its open market operation in United States government securities, its regulation of the interest rate on borrowings of member banks from Federal Reserve Banks and its imposition of non- earning reserve requirements on all depository institutions, such as the Bank, that maintain transaction accounts or non-personal time deposits. Transactions with Affiliates. Transactions between state member banks and any affiliate are governed by Sections 23A and 23B of the Federal Reserve Act. An affiliate of a state member bank is any company or entity which controls, is controlled by or is under common control with the state member bank. In a holding company context, the parent holding company of a state member bank (such as the Corporation) and any companies which are controlled by such parent holding company are affiliates of the savings association or state member bank. Generally, Sections 23A and 23B (i) limit the extent to which the institution or its subsidiaries may engage in "covered transactions" with any one affiliate to an amount equal to 10% of such institution's capital stock and surplus, and contain an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus and (ii) require that all such transactions be on terms substantially the same, or at least as favorable, to the institution or subsidiary as those provided to a non-affiliate. The term "covered transaction" includes the making of loans, purchase of assets, issuance of a guarantee and similar other types of transactions. In addition to the restrictions imposed by Sections 23A and 23B, no state member bank may (i) loan or otherwise extend credit to an affiliate, except for any affiliate which engages only in activities which are permissible for bank holding companies, or (ii) purchase or invest in any stocks, bonds, debentures, notes or similar obligations of any affiliate, except for affiliates which are subsidiaries of the state member bank. State member banks are also subject to the restrictions contained in Section 22(h) of the Federal Reserve Act on loans to executive officers, directors and principal stockholders. Under Section 22(h), loans to an executive officer and to a greater than 10% stockholder of a state member bank (18% in the case of institutions located in an area with less than 30,000 in population), and certain affiliated entities of either, may not exceed, together with all other outstanding loans to such person and affiliated entities the institution's loan to one borrower limit (generally equal to 15% of the institution's unimpaired capital and surplus and an additional 10% of such capital and surplus for loans fully secured by certain readily marketable collateral). Section 22(h) also prohibits loans, above amounts prescribed by the appropriate federal banking agency, to directors, executive officers and greater than 10% stockholders of a state member bank, and their respective affiliates, unless such loan is approved in advance by a majority of the board of directors of the institution with any "interested" director not participating in the voting. The FRB has prescribed the 21 loan amount (which includes all other outstanding loans to such person), as to which such prior board of director approval if required, as being the greater of $25,000 or 5% of capital and surplus (up to $500,000). Further, the FRB pursuant to Section 22(h) requires that loans to directors, executive officers and principal stockholders be made on terms substantially the same as offered in comparable transactions to other persons. State member banks are also subject to the requirements and restrictions of Section 22(g) of the Federal Reserve Act on loans to executive officers and the restrictions of 12 U.S.C. (S) 1972 on certain tying arrangements and extensions of credit by correspondent banks. Section 22(g) of the Federal Reserve Act requires that loans to executive officers of depository institutions not be made on terms more favorable than those afforded to other borrowers, requires approval for such extensions of credit by the board of directors of the institution, and imposes reporting requirements for and additional restrictions on the type, amount and terms of credits to such officers. Section 1972 prohibits (i) a depository institution from extending credit to or offering any other services, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or certain of its affiliates or not obtain services of a competitor of the institution, subject to certain exceptions, and (ii) extensions of credit to executive officers, directors, and greater than 10% stockholders of a depository institution by any other institution which has a correspondent banking relationship with the institution, unless such extension of credit is on substantially the same terms as those prevailing at the time for comparable transactions with other persons and does not involve more than the normal risk of repayment or present other unfavorable features. Dividend Limitations. The Bank's ability to pay dividends is governed by the Maryland Financial Institutions Code and the regulations of the FRB. Under the Maryland Financial Institutions Code, a Maryland bank (1) may only pay dividends from undivided profits or, with prior regulatory approval, its surplus in excess of 100% of required capital stock and (2) may not declare dividends on its common stock until its surplus fund equals the amount of required capital stock or, if the surplus fund does not equal the amount of capital stock, in an amount in excess of 90% of net earnings. The Bank's payment of dividends are subject to the FRB's Regulation H, which limits the dividends payable by a state member bank to the net profits of the Bank then on hand, less the Bank's losses and bad debts. Additionally, the FRB has the authority to prohibit the payment of dividends by a state member bank when it determines such payment to be an unsafe and unsound banking practice. Finally, the Bank would not be able to pay dividends on its capital stock if its capital would thereby reduced below the remaining balance of the liquidation account established in connection with its mutual to stock conversion. Regulation of the Corporation General. The Corporation, as the sole shareholder of the Bank, is a bank holding company and registered as such with the FRB. Bank holding companies are subject to comprehensive regulation by the FRB under the Bank Holding Company Act of 1956, as amended (the "BHCA"), and the regulations of the FRB. As a bank holding company, the Corporation is required to file with the FRB annual reports and such additional information as the FRB may require, and is subject to regular examinations by the FRB. The FRB also has extensive enforcement authority over bank holding companies, including, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to require that a holding company divest subsidiaries (including its bank subsidiaries). In general, enforcement actions may be initiated for violations of law and regulations and unsafe or unsound practices. Under the BHCA, a bank holding company must obtain FRB approval before: (i) acquiring, directly or indirectly, ownership or control of any voting shares of another bank or bank holding company if, after such acquisition, it would own or control more than 5% of such shares (unless it already owns or controls the majority of such shares); (ii) acquiring all or substantially all of the assets of another bank or bank holding company; or (iii) merging or consolidating with another bank holding company. 22 The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company which is not a bank or bank holding company, or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or providing services for its subsidiaries. The principal exceptions to these prohibitions involve certain non-bank activities which, by statute or by FRB regulation or order, have been identified as activities closely related to the business of banking or managing or controlling banks. The list of activities permitted by the FRB includes, among other things, operating a savings institution, mortgage company, finance company, credit card company or factoring company; performing certain data processing operations; providing certain investment and financial advice; underwriting and acting as an insurance agent for certain types of credit-related insurance; leasing property on a full-payout, non-operating basis; selling money orders, travelers' checks and United States Savings Bonds; real estate and personal property appraising; providing tax planning and preparation services; and, subject to certain limitations, providing securities brokerage services for customers. Under Maryland statutory law, acquisitions of 25% or more of the voting stock of a commercial bank or a bank holding company and other acquisitions of voting stock of such entities which affect the power to direct or to cause the direction of the management or policy of a commercial bank or a bank holding company must be approved in advance by the Commissioner. Any person proposing to make such an acquisition must file an application with the Commissioner at least 60 days before the acquisition becomes effective. The Commissioner may deny approval of any such acquisition if the Commissioner determines that the acquisition is anticompetitive or threatens the safety or soundness of a banking institution. Any voting stock acquired without the approval required under the statute may not be voted for a period of 5 years. This restriction is not applicable to certain acquisitions by bank holding companies of the stock of Maryland banks or Maryland bank holding companies which are governed by Maryland's holding company statute. Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 and its Application in Maryland. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the "Act") was enacted to ease restrictions on interstate banking. Effective September 29, 1995, the Act allows the FRB to approve an application of an adequately capitalized and adequately managed bank holding company to acquire control of, or acquire all or substantially all of the assets of, a bank located in a state other than such holding company's home state, without regard to whether the transaction is prohibited by the laws of any state. The FRB may not approve the acquisition of a bank that has not been in existence for the minimum time period (not exceeding five years) specified by the statutory law of the host state. The Act also prohibits the FRB from approving an application if the applicant (and its depository institution affiliates) controls or would control more than 10% of the insured deposits in the United States or 30% or more of the deposits in the target bank's home state or in any state in which the target bank maintains a branch. The Act does not affect the authority of states to limit the percentage of total insured deposits in the state which may be held or controlled by a bank or bank holding company to the extent such limitation does not discriminate against out-of-state banks or bank holding companies. Individual states may also waive the 30% state-wide concentration limit contained in the Act. Pursuant to the Act, the FRB may approve an application of an adequately capitalized and adequately managed non-Maryland bank holding company to acquire control of, or acquire all or substantially all of the assets of, a Maryland bank, as long as certain requirements of the Act are met. Additionally, the Act authorizes the federal banking agencies to approve interstate merger transactions without regard to whether such transaction is prohibited by the law of any state, unless the home state of one of the banks opts out of the Act by adopting a law after the date of enactment of the Act and prior to June 1, 1997 that applies equally to all out-of-state banks and expressly prohibits merger transactions involving out-of-state banks. The State of Maryland has enacted legislation that authorizes interstate mergers involving Maryland banks. The Maryland statute also authorizes out-of-state banks to establish branch offices in Maryland by means of merger, branch acquisition or de novo branching. - -- ---- 23 Dividends. The FRB has issued a policy statement on the payment of cash dividends by bank holding companies, which expresses the FRB's view that a bank holding company should pay cash dividends only to the extent that the company's net income for the past year is sufficient to cover both the cash dividends and a rate of earning retention that is consistent with the company's capital needs, asset quality and overall financial condition. The FRB also indicated that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. Furthermore, under the prompt corrective action regulations adopted by the FRB pursuant to FDICIA, the FRB may prohibit a bank holding company from paying any dividends if the holding company's bank subsidiary is classified as "undercapitalized". See "Depository Institution Regulation -- Prompt Corrective Regulatory Action." Bank holding companies are required to give the FRB prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, is equal to 10% or more of the their consolidated retained earnings. The FRB may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, FRB order, or any condition imposed by, or written agreement with, the FRB. Capital Requirements. The FRB has established capital requirements, similar to the capital requirements for state member banks described above, for bank holding companies with consolidated assets of $150 million or more. As of December 31, 1999, the Corporation's levels of consolidated regulatory capital exceeded the FRB's minimum requirements. Federal and State Taxation The Corporation and its subsidiaries currently file a consolidated federal income tax return based on a fiscal year ending December 31. The Bank is subject to the provisions of the Internal Revenue Code of 1986, as amended (the "Code") in the same general manner as other corporations. In its form as a savings bank until March 1997, through tax years beginning before December 31, 1995, savings associations such as the Bank which met certain definitional tests and other conditions prescribed by the Code benefitted from certain favorable provisions regarding their deductions from taxable income for annual additions to their bad debt reserve. For purposes of the bad debt reserve deduction, loans are separated into "qualifying real property loans," which generally are loans secured by interests in real property, and nonqualifying real property loans, which are all other loans. The bad debt reserve deduction with respect to nonqualifying loans must be based on actual loss experience. The Bank currently determines the amount of the bad debt reserve deduction with respect to qualifying real property loans based upon actual loss experience (the "experience method"). Neither the Corporation nor the Bank's federal income tax returns have been audited by the Internal Revenue Service during the past five years. For 1997, the Bank was required to file a franchise tax return with the State of Maryland which computes the tax at a rate of 7% on the Bank's net earnings, as defined. Under current tax laws, the Bank is no longer subject to the franchise tax, but files a corporate return with the State of Maryland. For additional information regarding federal and state taxes payable by the Corporation, see Note 8 of the Notes to Consolidated Financial Statements. 24 Competition The Bank faces strong competition in the attraction of deposits (its primary source of lendable funds) and in the origination of real estate loans. Its most direct competition for deposits and loans comes from other banks, savings and loan associations, and federal and state credit unions located in its primary market area. The Bank faces additional significant competition for investors' funds from short-term money market securities and other corporate and government securities. The Bank competes for loans principally through the interest rates and loan fees it charges and the efficiency and quality of the services it provides borrowers, real estate brokers, and home builders. It competes for deposits by offering depositors a wide variety of savings accounts, checking accounts, convenient office locations, tax-deferred retirement programs, brokerage services and miscellaneous services. The Bank has also utilized direct mail, billboard and newspaper advertising to help increase deposits. It provides ongoing training for its staff in an attempt to ensure high quality service. Personnel As of December 31, 1999, the Bank had 70 full-time employees and 11 part- time employees. The employees are not represented by a collective bargaining agreement. The Bank believes its employee relations are good. Item 2. Properties - ------------------- The following table sets forth the location of the Bank's offices, as well as certain additional information relating to these offices as of December 31, 1999. Year Facility Leased Approximate Office Commenced or Square Location Operation Owned Footage - -------- ---------- -------- ----------- Main Office 1974 Owned 16,500 3035 Leonardtown Road Waldorf, Maryland Branch Office (1) 1974 Owned 1,000 502 Great Mills Road Lexington Park, Maryland Branch Office (1) 1992 Owned 2,500 Rt. 235 and Maple Road Lexington Park, Maryland Branch Office 1961 Owned 2,500 Route 5 and Lawrence Avenue Leonardtown, Maryland Branch Office (2) 1990 Leased 24,200 Potomac Square 729 North 301 Highway La Plata, Maryland Branch Office 1991 Leased 1,400 10321 Southern Md. Blvd Dunkirk, Maryland (continued on following page) 25 Year Facility Leased Approximate Office Commenced or Square Location Operation Owned Footage - -------- ---------- -------- ----------- Branch Office 1996 Owned 2,500 8010 Matthews Road Bryans Road, Maryland Branch Office (3) 1998 Leased (Land) 2,840 20 St. Patrick's Drive Owned (Building) Waldorf, Maryland Branch Office 1997 Leased 126 Charles County Community College 8730 Mitchell Road La Plata, Maryland Branch Office 1999 Leased 600 10195 Berry Road Waldorf, Maryland - ------------------- (1) The Bank purchased land early in 1992, and built a new Lexington Park branch office which opened in August 1992. The Bank is currently leasing out the former office space and is actively seeking to sell the site. (2) Includes land purchased in February 1993 as potential branch location. (3) The Bank purchased the location in 1998. The building is owned by the Bank with the land on a lease basis. NCR currently maintains all accounting records for the Bank's deposits and loans. The Bank's general ledger and other accounting needs are met through the use of internal computer systems. The net book value of the Bank's investment in premises and equipment less accumulated depreciation totaled $4.5 million at December 31, 1999. See Note 5 of the Notes to Consolidated Financial Statements. Item 3. Legal Proceedings - -------------------------- Neither the Corporation, the Bank, nor any subsidiary is engaged in any legal proceedings of a material nature at the present time. From time to time the Bank is a party to legal proceedings in the ordinary course of business. Item 4. Submission of Matters to a Vote of Security Holders - ------------------------------------------------------------ No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year ended December 31, 1999. PART II Item 5. Market for the Registrant's Common Stock and Related Security Holder - ----------------------------------------------------------------------------- Matters ------- The information contained under the section caption "Stock Information" in the Annual Report is incorporated herein by reference. 26 Item 6. Selected Financial Data - -------------------------------- The information contained in the table captioned "Selected Consolidated Financial and Other Data" in the Annual Report is incorporated herein by reference. Item 7. Management's Discussion and Analysis of Financial Condition and Results - -------------------------------------------------------------------------------- of Operations ------------- The information contained in the section captioned "Results of Operations" in the Annual Report is incorporated herein by reference. Item 8. Financial Statements and Supplementary Data - ---------------------------------------------------- The financial statements contained in the Annual Report which are listed under Item 14 herein, are incorporated herein by reference. Item 9. Changes in and Disagreements with Accountants on Accounting and - ------------------------------------------------------------------------ Financial Disclosure -------------------- Not applicable. PART III Item 10. Directors and Executive Officers of the Registrant - ------------------------------------------------------------ The information contained under the section captioned "Proposal I -- Election of Directors" in the Corporation's definitive proxy statement for the Corporation's 2000 Annual Meeting of Stockholders (the "Proxy Statement") is incorporated herein by reference. The executive officers of the Corporation are as follows: Michael L. Middleton (52 years old) is President and Chief Executive Officer of the Corporation and the Bank. He joined the Bank in 1973 and served in various management positions until 1979 when he became president of the Bank. Mr. Middleton is a Certified Public Accountant and holds a Masters of Business Administration. As President and Chief Executive Officer of the Bank, Mr. Middleton is responsible for the overall operation of the Bank pursuant to the policies and procedures established by the Board of Directors. Mr. Middleton is a member of the Rotary Club of Waldorf and is a Paul Harris Fellow. Since December 1995, Mr. Middleton has served on the Board of Directors of the Federal Home Loan Bank of Atlanta and also serves as its Board Representative to the Council of Federal Home Loan Banks. In January 2000, Mr. Middleton was appointed to the National Association of Home Builders Mortgage Roundtable. C. Marie Brown (57 years old) has been employed with the Bank for over 27 years and has served as Chief Operating Officer since 1999. Prior to her appointment as Chief Operating Officer, Ms. Brown served as Senior Vice President of the Bank. She is a supporter of the Handicapped and Retarded Citizens of Charles County, of Zonta and serves on various administrative committees of the Hughesville Baptist Church and the board of the Charles County Chapter of the American Red Cross. H. Beaman Smith (54 years old) was the Treasurer of the Corporation in 1998 and became Secretary-Treasurer in January 1999 and has been the president of Accoware, a computer software company, since 1989. Prior to that time, Mr. Smith was a majority owner of the Smith's Family Honey Company in Bryans Road, Maryland. 27 Mr. Smith is a Vice President of Fry Plumbing Company of Washington, D.C., a Trustee of the Ferguson Foundation, a member of the Bryans Road Sports Council and the Treasurer of the Mayaone Association. Eileen M. Ramos (43 years old) joined the Bank as Chief Financial Officer in September 1994. Prior to that time, Ms. Ramos was a partner with the accounting firm of Councilor, Buchanan & Mitchell, P.C. She is a member of the American Institute of CPAs, the District of Columbia Institute of CPAs and the Financial Managers Society. Gregory C. Cockerham (45 years old) joined the Bank in November 1988 and has served as Senior Vice President of Lending since 1996. Prior to his appointment as Senior Vice President, Mr. Cockerham served as Vice President of the Bank. Mr. Cockerham has been in banking for 22 years. He is a Paul Harris Fellow with the Rotary Club of Charles County and serves on various civic boards in the County. Item 11. Executive Compensation - -------------------------------- The information contained under the section captioned "Proposal I -- Election of Directors - Executive Compensation" in the Proxy Statement is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management - ------------------------------------------------------------------------ (a) Security Ownership of Certain Owners The information required by this item is incorporated herein by reference to the sections captioned "Proposal I -- Election of Directors" and "Voting Securities and Principal Holders Thereof" of the Proxy Statement. (b) Security Ownership of Management Information required by this item is incorporated herein by reference to the section captioned "Proposal I --Election of Directors" of the Proxy Statement. (c) Changes in Control Management of the Corporation knows of no arrangements, including any pledge by any person of securities of the Corporation, the operation of which may at a subsequent date result in a change in control of the registrant. Item 13. Certain Relationships and Related Transactions - -------------------------------------------------------- The information required by this item is incorporated herein by reference to the section captioned "Proposal I -- Election of Directors" and "Transactions with the Corporation and the Bank" of the Proxy Statement. PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K - -------------------------------------------------------------------------- (a) 1. Report of Independent Certified Public Accountants* Tri-County Financial Corporation* (a) Consolidated Statements of Financial Condition at December 31, 1999 and 1998 (b) Consolidated Statements of Income for the Years Ended December 31, 1999, 1998 and 1997 (c) Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 1999, 1998 and 1997 28 (d) Consolidated Statements of Cash Flow for the Years Ended December 31, 1999, 1998 and 1997 (e) Notes to Consolidated Financial Statements - ------------------------- * Incorporated by reference to the Annual Report. 2. All schedules have been omitted as the required information is either inapplicable or included in the Notes to Consolidated Financial Statements. 3. Exhibits (3)(a) Articles of Incorporation of Tri-County Financial Corporation** (3)(b) Bylaws of Tri-County Financial Corporation ** (10)(a) Tri-County Financial Corporation 1995 Stock Option and Incentive Plan, as amended *** (10)(b) Tri-County Financial Corporation 1995 Stock Option Plan for Non-Employee Directors, as amended *** (10)(c) Employment Agreements with Michael L. Middleton, as amended, C. Marie Brown, as amended, and Gregory C. Cockerham *** (13) Annual Report to Stockholders for the Fiscal Year Ended December 31, 1999 (21) Subsidiaries of the Registrant (23) Consent of Stegman & Company (27) Financial Data Schedule (b) No reports on Form 8-K have been filed during the last quarter of the fiscal year covered by this report. (c) The exhibits required by Item 601 of Regulation S-K are either filed as part of this Annual Report on Form 10-K or incorporated by reference herein. (d) There are no other financial statements and financial statement schedules which were excluded from the Annual Report pursuant to Rule 14a- 3(b)(1) which are required to be included herein. --------------- ** Incorporated by reference to the registrant's Form S-4 Registration Statement No. 33-31287. *** Incorporated by reference to the registrant's Form 10-K for the fiscal year ended December 31, 1998. 29 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. TRI-COUNTY FINANCIAL CORPORATION Date: March 27, 2000 By: /s/ Michael L. Middleton ----------------------------------- Michael L. Middleton President and Chief Executive Officer (Duly Authorized Representative) Date: March 27, 2000 By: /s/ Eileen M. Ramos ----------------------------------- Eileen M. Ramos Chief Financial Officer (Duly Authorized Representative) Pursuant to the requirement of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. By: /s/ Michael L. Middleton By: /s/ Herbert N. Redmond, Jr. ------------------------------ ----------------------------------- Michael L. Middleton Herbert N. Redmond, Jr. (Director, President and Chief (Director) Executive Officer) Date: March 27, 2000 Date: March 27, 2000 By: /s/ Henry A. Shorter, Jr. By: /s/ W. Edelen Gough, Jr. ------------------------------ ----------------------------------- Henry A. Shorter, Jr. W. Edelen Gough, Jr. (Director) (Director) Date:March 27, 2000 Date: March 27, 2000 By: /s/ C. Marie Brown By: /s/ Gordon A. O'Neill ------------------------------ ----------------------------------- C. Marie Brown Gordon A. O'Neill (Director and Chief Operating (Director) Officer) Date: March 27, 2000 Date: March 27, 2000 By: /s/ Beaman Smith ------------------------------ Beaman Smith (Director and Secretary/Treasurer) Date: March 27, 2000 30 INDEX TO EXHIBITS Exhibit No. Description - ----------- ----------- (3)(a) Articles of Incorporation of Tri-County Financial Corporation* (3)(b) Bylaws of Tri-County Financial Corporation* (10)(a) Tri-County Financial Corporation 1995 Stock Option and Incentive Plan, as amended** (10)(b) Tri-County Financial Corporation 1995 Stock Option Plan for Non-Employee Directors, as amended** (10)(c) Employment Agreements with Michael L. Middleton, as amended, C. Marie Brown, as amended, and Gregory C. Cockerham** (13) Annual Report to Stockholders for the Fiscal Year Ended December 31, 1999 (21) Subsidiaries of the Registrant (23) Consent of Stegman & Company (27) Financial Data Schedule - ----------------- * Incorporated by reference to the registrant's Form S-4 Registration Statement No. 33-31287. ** Incorporated by reference to the registrant's Form 10-K for the fiscal year ended December 31, 1998. 31 EX-13 2 ANNUAL REPORT Dear Shareholder: I am pleased to report to you the results of the operations of Tri-County Financial Corporation and its banking subsidiary, Community Bank of Tri County for the year ended December 31, 1999. The total assets of the Company increased by 7.75% to $222.9 million dollars. Net income for the period declined slightly to $2.2 million, down 9.6% over 1998's record year. The Basic Income per Share was $2.75 versus $3.00 for 1998 and $2.53 for 1997. The operating environment over the last five quarters has been a study in contrast. In late 1998, the Federal Reserve was clearly guarding against deflation and lowered short-term interest rates. Some three quarters later, it reversed policy and moved to guard against inflation! The impact of this unique policy shift was to lower the yield on the Bank's earning assets and precipitate refinancing of the underlying principle. This produced a change in the portfolio's yield on interest earning assets of minus 40 basis points for 1999 as compared to minus 12 basis points for 1998. To date, there have been five changes in the short-term rates accompanied by a flat yield curve, which affects the spread in which to operate the bank. During this period, the Bank continued to follow its long-term business plan of migrating its portfolio to that of a commercial bank. It was very successful in attracting those assets which should provide a better revenue stream than that of a residential lender. Loan balances in commercial real estate products increased 52% while its commercial lines of credit grew 63%. In total, loans targeted by its business plan totaled 52% of total loans in 1999 up 12% from 1998's balance. In conjunction with our efforts to restructure our operations, your Board and management have embraced a sales culture at all levels of the Bank. A full time sales coordinator has been hired and a formal sales training curriculum has been developed. Every employee must complete the class and all branch managers are required to achieve a specific level of sales effectiveness as part of their incentive plan. The volatility in the stock price of financial institutions and price deflation from historic highs presented the Board with the opportunity to purchase and retire a portion of the stock offered for sale during 1999. The price at which the stock was purchased was accretive to the earnings per share of the Company. While a very small percentage of our stock actually trades, less than 5% annually of the outstanding shares, the stock repurchase strategy effectively utilizes capital to add liquidity to the market. With the conversion to a commercial bank well underway, the Company has benefited from this well timed strategy by gaining recognition as a bank holding company with a Blue Ribbon bank designation by Veribanc, an independent bank rating company. In my last correspondence with our shareholders, I outlined the dividend strategy that the Board is pursuing. That is, to provide cash dividends, in lieu of stock dividends, that compare favorably to other publicly traded commercial banks. To that point, the Board increased the dividend payable in 2000 by 50% to $.30 per share. As we enter a new phase in our economic environment, your Board and management are confident that your Company will continue in its endeavor to be the leading community banking company in Southern Maryland. With your continued support, I am confident that we can obtain that goal in the near future. Yours truly, /s/ Michael L. Middleton Michael L. Middleton President and Chairman MANAGEMENT'S DISCUSSION AND ANALYSIS GENERAL For the year ended December 31, 1999, the Community Bank of Tri-County ("the Bank") provided the Tri-County Financial Corporation ("the Company") with earnings of $2.2 million, down 9.6% from the preceding year ended December 31, 1998. The decline in earnings reflected the economic events of the third quarter of 1998, during the international bond crisis, wherein the Federal Reserve lowered short-term interest rates to add liquidity to the market. That move forced down rates available on investments and triggered extensive loan portfolio refinancing. This resulted in lower revenue from those sources during 1999. Subsequent changes in the Federal Reserve position on rates caused a rise in rates during the second half of 1999. The combined effect of accelerated principal curtailments in the portfolio with lower yielding reinvestment opportunities followed by a series of quick increases in the short term rates produced an unusual environment for the Bank to operate. Entering its fourth year as a commercial bank, the business plan of the Bank, specifies areas of portfolio growth and targeted marketing programs to create an earnings stream comparable to established community banks. The key component of this strategy is to increase the levels of commercial and consumer loan products. Utilizing the Bank's existing delivery systems, management began to capitalize on the lucrative niche for community based lending. Market response was favorable and the initial momentum generated even greater increases in commercial and consumer loans than management had expected. The outcome of management's efforts to restructure the portfolio and lines of business is evident in the percentages of growth in targeted lines. Net loans receivable increased by $14.1 million, or 10.6% in 1999. Commercial real estate loans grew by $10.2 million or 51.8 % and lines of credit grew by $3.9 million or 62.7%. Growth in the home equity product line was minimal due to the low interest rate environment experienced during the first half of 1999 wherein many borrowers paid off their second mortgages in conjunction with refinancing their first mortgages to a lower rate. There are additional prepayment risks associated with commercial real estate lending since payments on loans secured by commercial real estate are typically dependent on the successful operation or management of the properties, which in turn is dependent on favorable real estate and other economic conditions. The Bank will therefore be increasingly exposed to these risks as it implements its business plan over time. On the liability side of the balance sheet, transactional accounts comprise $51.6 million, or 33.2% of the deposit base of the Bank at December 31, 1999 compared to $38.5 million or 25.3% at December 31, 1998. This increase resulted from the Bank's development of accounts for its small business customers as well as the creation of a money market indexed account with check withdrawal privileges. Residential mortgage lending continued to provide loans for the Bank's portfolio and produced a volume of $45.9 million in loans, down 16.3 % from 1998's level. In the first half of 1999, low interest rates continued to stimulate refinancing activity. The majority of fixed rate long-term loans were sold in the secondary market, with the servicing retained by the Bank, while adjustable rate mortgages and certain shorter maturity fixed rate loans were originated for the Bank's portfolio. Loan production was adversely affected in the second half of the year by a series of interest rate increases made by the Federal Reserve in an effort to contain the economy's growth. The margin between rates earned on the Bank's loan portfolio and the rates paid on its customer deposits declined by 31 basis points from 5.09% to 4.78%. This suggests that a narrowing of margins may continue to erode earnings in the future. The Bank is continuing to search for new markets and facilities to deliver its products to the region in a cost efficient manner. A prime location adjacent to Southern Maryland's only regional mall was acquired in late 1997 and put into operation in the first quarter of 1998. This provided a highly visible commercial branch for further development of market share. The Bank is expanding on its "micro-branching" concept by using lobbies connected with convenience stores while providing full service drive-in hours and ATM access. These micro-branches will be used as in-fill delivery sites and will be supported by our anchor branch staffs. Additional ATM sites have been acquired in several retail establishments and management continues to seek such opportunities to serve the local market. These steps are taken to generate fee income and further advance the name recognition of the Bank. In an effort to provide a wider range of services and products to Bank customers and generate additional fee income, the Bank entered into an agreement with UVEST to provide a wide range of investment products and services to the Bank's customers. Management anticipates that fee income from these sources will develop slowly, but the customer relationships established will solidify Community Bank's position in the area market. FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company's net income for 1999 decreased $228,000 or $.25 in basic income per share over 1998's level. This was a continuation of the slowing of the earnings growth which began in 1998. The flat yield curve produced few opportunities to increase the interest rate spread when the cost of funds tracked so closely with the yield on investments and loans during the year. The average yield on all interest-earning assets was 7.75% for 1999 compared to 8.15% in 1998 and 8.27% in 1997. During the first half of the year, the interest rate yield curve was flat with a general decline in the level of rates earned. The decrease in the weighted average yield occurred as accelerated principal curtailments or payoffs were received and somewhat lower yields were available on the investments acquired with the cash received. In the second half of 1999, a series of interest rate increases slowed loan production significantly and immediately affected the repricing of short-term money market indexed deposits. During the period of low rates in 1998 and early 1999, the Bank experienced rapid loan prepayment. Management's asset/liability strategy was to protect against upside movements in interest rates. Because long term maturity extension of investments would have been counterproductive to the strategy, intermediate range investments and loans were pursued. As evidenced in the "Gap" chart in the "Market Risk Analysis" section of this discussion, the Bank has exposure to rising rates, particularly in the short to moderate term sectors. For several years the yield curve has been essentially flat which has imposed significant pressure on the Bank's net spread. This is because no appreciable relief is obtained in the cost of money with short and intermediate term rates tracking so close to the long-term rates. The decline in the level of rates reduced the Bank's cost of funds at a slower pace than the decline in asset returns. The average rate paid on all interest-bearing liabilities was 3.92% in 1999, 4.24% in 1998 and 4.37% in 1997. The change in the cost of funds was -32 basis points ("bp") in 1999 versus -13 bp in 1998. This contrasted to a net change in the yield on interest earning assets of -40 bp in 1999 and -12 bp in 1998. The Board of Directors of the Bank monitors the situation carefully to develop a balance in the portfolio that will conservatively position the Bank. The net interest rate spread was 3.83% in 1999 compared to 3.91% in 1998 and 3.90% in 1997. The trend has been toward a narrowing of the yield over the past several years. The interest rate spread may increase in the future if a traditional yield curve pattern is regained. If the classic pattern of inflationary pressures and interest rate volatility return, as indicated by the recent Federal Reserve moves, the repricing of the Bank's earning assets should increase returns over time. An interest rate sensitivity analysis follows this section and will provide a more detailed discussion. As previously stated, the continued negative effect of the low long term rate environment on the refinancing activity of the fixed rate portfolio and of the loans serviced for others has decreased loan yields. During the first half of 1999, the Bank's adjustable rate mortgage ("ARM") portfolio repriced at levels consistent with or above the current fixed rates found in the market. That exposed the ARM portfolio to a faster runoff of loans. The loan portfolio continues its quality and has no loans identified as impaired. The nonaccrual loans for 1999 totaled $218,000 compared to $269,000 for 1998 and $160,000 for 1997. Increasing levels of commercial and consumer loans are expected to create some additional collection activity for the Bank, but these loans are still relatively new and the Bank has not yet experienced an increase in delinquencies in these loan groups. The Bank owned real estate acquired through foreclosure at the end of the year with a fair market value of approximately $176,000. OPERATIONAL ANALYSIS Noninterest expense increased by 14.8% or $809,000 to $6,276,000 for 1999 compared to $5,467,000 in 1998 and $4,877,000 for 1997. Salaries and employee benefits generated the largest line item dollar increase in 1999, $485,000, as higher personnel levels were required to handle the increase in transactional and business activity and to staff the growing branch network and middle management. The Bank has implemented a branch wide incentive plan for its managers that is based on specific operational goals as well as corporate rates of return and loan quality criteria. The managers may receive cash incentives as well as stock options based on their success in achieving strategic goals. This greatly expands the coverage of employees under an incentive-based pay structure and more closely aligns the manager or executive to the overall performance of the Bank. Further incentive plans for the remaining employees are currently under development. Occupancy expense increased as new branch facilities were on line for a full year. Older facilities and the administrative offices have been expanded and reconditioned. Deposit insurance costs are incurred at a level just under $90,000 since the conversion to a commercial bank. YEAR 2000 ISSUES The Bank successfully completed the Y2K date change without incident. The Bank began its Y2K program in early 1997 and included complete analysis of all Bank functions, documentation of the technology reliance and rating of the systems in order of critical need. Contingency plans were written and timetables developed for the implementation of the contingency operations in the event of failure in any given area. Testing of the plans was performed for critical areas. Additional cash was maintained on hand to meet potential customer demands, taking the asset out of interest earning investments. Additional security was required to safeguard the cash and protect the staff during what was deemed to be a period more susceptible to robbery attempts. Generators and emergency lighting systems were acquired to allow operation of critical systems in the event of electrical failure. The cost of addressing potential problems related to the date change is estimated at $550,000. NET PREMISES AND EQUIPMENT Net premises and equipment increased by 4.6% or $200,000 in 1999 compared to a 3% or $127,000 increase in 1998 over 1997's level. Continued investment in technology platforms, and various internal office expansion and renovation required capital outlays in 1999. WHOLESALE BORROWINGS The Bank's wholesale borrowing, consisting mainly of advances from the Federal Home Loan Bank of Atlanta, increased to $44.4 million at December 31, 1999 from $32.9 million at December 31, 1998. These borrowings were used to fund specific loan projects or to create arbitrages with authorized investments for a managed interest spread. This strategy allows for the prudent leveraging of net worth to maximize revenue production while managing asset and liability interest rate risk. STOCKHOLDERS' EQUITY Stockholders' equity grew by .7%, or $140,000 during 1999 to 21,115,000 compared to an increase of 10.7% or $2,045,000 to $20,975,000 during 1998. This represents an average equity to average assets ratio of 9.8%, down from 10.1% in 1998. A net unrealized loss on investment and mortgage-backed securities available for sale was experienced in 1999 due to the rapid change in the interest rate posture of the Federal Reserve. A loss of $1.4 million, net of deferred tax, in 1999 as compared to a gain of $207,000 in 1998 was recognized as an adjustment to stockholders' equity. The net unrealized gain or loss is calculated on a monthly basis and will be reflected in the quarterly statements to the regulatory agencies and shareholders. The Company's total risk based capital ratio at December 31, 1999 was 17.23% or $23,486,000 compared to 18.27% or $22,023,000 at December 31, 1998. The Tier I risk based capital level at December 31, 1999 was $21,833,000 or 16.02% compared to $20,483,000 or 17.00% at December 31, 1998. A discussion of the quantitative measures of capitalization and regulatory capital requirements of the Company and its banking subsidiary may be found in Footnote 14 "Regulatory Matters" of the Consolidated Financial Statements. At December 31, 1999, the Company and the Bank exceeded all capital requirements and were considered to be "well-capitalized" under regulatory definitions. During the year, the Board of Directors of the Company continued to provide liquidity to its shareholder base through stock repurchases. The Company purchased and retired 24,803 shares for $657,000 in 1999 and 20,039 shares for $474,000 in 1998. LIQUIDITY The Company's liquidity management policies for the Bank are designed to provide for prudent levels of liquidity to be maintained at all times, consistent with the nature of the business being conducted by the Bank. The assets classified as Investment Securities available-for-sale are available for leveraging as well as for immediate sale if the situation dictates that course of action. Additionally, the Federal Home Loan Bank of Atlanta is extensively utilized as the Bank's liquidity source in its asset/liability management strategy. The Bank currently has approval to borrow up to thirty percent (30%) of its assets. At December 31, 1999, it had $44.4 million outstanding or 19.9% of its assets. The year 2000 liquidity plan has been developed and is currently being operated in conjunction with the guidelines of the Federal Reserve and with the cooperation of the Federal Home Loan Bank, its primary wholesale source. MARKET RISK ANALYSIS The market risk of the Bank is managed through the Board's Asset and Liability Committee (ALCO). Together with the Bank's management, the Committee reviews the sensitivity of the market value of the portfolio equity and interest rate sensitivity of net income. The changes in the market value of portfolio equity as well as the interest income sensitivity are caused by shifts in the market rates of interest and can cause a negative as well as a positive impact in given scenarios. The portfolio is subjected to periodic modeling to test the effects of sudden and sustained interest rate shocks on the market value and the net interest income sensitivity. The Basle Committee on Banking Supervision has set standard measures of portfolio market value equity and interest income sensitivity in a shock environment of an immediate up or down 200 basis point shift in assumed interest rates. The impact of such a shock on the Bank's portfolio is as follows: 1999 1998 Sensitivity of market value of portfolio equity: Interest rate changes: Up 200 basis points -13% -12% Down 200 basis points +4% +5% Sensitivity of net interest income: Interest rate changes: Up 200 basis points -1% -1% Down 200 basis points +3% +1% The change in percentage for the market value of portfolio equity declined slightly in both the adverse scenario of up 200 basis points in interest rate movement and in the down 200 basis shock. This reflects the impact of multi- year flat yield curves at lower rate levels. As prepayments have occurred, reinvestment of the proceeds was at lower yields. An immediate market rate increase would make those new investments less valuable. Because the net income of the Bank and Company is derived through the interest spread of the portfolio, the ALCO committee is less concerned with the shock of interest rates on the market value than it is on the interest rate sensitivity because the assets are employed for their income production rather than value appreciation upon sale. The levels of change for both the market value of the portfolio equity and the net interest income sensitivity fall within the policy benchmarks established by the Board. Interest rate sensitivity reflects the change in the Bank's net interest income given assumed interest rate shifts. Neither scenario generates a severe impact to the Bank's earnings. In the scenarios presented, the most detrimental for the Bank is an upward movement of rates. An upward rate movement would reduce the market value of the portfolio, but with no intent to liquidate, the decline would affect earnings. Due to the composition of the cost of funds and the percentage of wholesale borrowings needed to finance its activities, the Bank may be adversely affected in the event of rising rates. Typically, wholesale borrowings are in large denominations and reprice quickly to reflect sudden changes in the global market. Retail deposits typically are in smaller amounts and are less likely to respond to shifts in rates in a short time period. Therefore, the Bank's portfolio has been structured with an attempt to reasonably minimize the impact on earnings from sudden and prolonged upward shifts in interest rates. Interest rate sensitivity may also be analyzed by examining the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring an institution's interest rate sensitivity "gap". An asset or liability is said to be interest rate sensitive within a specific period if it will mature or reprice within that period. The interest rate sensitivity gap is defined as the difference between the amount of interest earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that time period. Gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities, and is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. Generally, during a period of rising interest rates, such as was the case in the second half of 1999, a negative gap would adversely affect net interest income and a positive gap would result in an increase in net interest income. Conversely, during a period of falling interest rates, a negative gap would result in an increase in net interest income and a positive gap would adversely affect net interest income. The following table illustrates the "gap" position of the Bank at December 31, 1999:
0 to 90 91 to 365 Over 1 to Over 3 to Over 5 days days 3 years 5 years years --------- --------- -------- -------- ------- (amounts in thousands) Rate Sensitive Assets: Interest bearing deposits with banks $ 3,063 $ - $ - $ - $ - Investment securities 12,442 - 3,946 - 44,503 Loans 26,582 24,176 63,502 11,506 21,717 -------- ------- -------- -------- ------- Total assets $ 42,087 $24,176 $ 67,448 $ 11,506 $66,220 ======== ======= ======== ======== ======= Rate Sensitive Liabilities: Noninterest bearing deposits $ 10,102 $ - $ - $ - $ - Interest bearing demand deposits 18,331 - - - - Money market deposits 34,669 - - - - Regular savings deposits 21,427 - - - - Time deposits 12,325 25,634 27,647 4,897 - Other borrowed funds and long-term debt 3,398 - 11,400 10,000 10,000 ------- ------- -------- ------- ------- Total liabilities $110,252 $25,634 $39,047 $14,897 $10,000 ======== ======= ======= ======= ======= Interest rate sensitivity gap $(68,165) $(1,458) $28,401 $(3,391) $56,220 Cumulative interest rate sensitivity gap $(68,165) $(69,623) $(41,222) $(44,613) $11,607
While a perfectly matched portfolio of assets and borrowings would seem optimal, in community banking enterprises, there exists too little margin for normal profitability and coverage of the cost of operations to attempt a complete match. Therefore, the Board of Directors, through its ALCO committee, monitors certain levels of mismatch in the portfolio consistent with the net worth leveraging policies to maintain a profitable level of mismatched assets and their funding costs. IMPACT OF INFLATION The consolidated financial statements and related financial data presented herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the price of goods and services. In the current interest rate risk environment, liquidity and the maturity structure of the Bank's assets and liabilities are critical to the maintenance of acceptable performance levels. STOCK INFORMATION Tri-County Financial Corporation's stock is not traded or listed on a public exchange. However, stock does change hands over the course of the year. In 1999, the Company was made aware of several trades which occurred. During 1999, a total of 35,672 shares traded, with a high price of $33.00 and a low price of $20. The weighted average price was $26.61. The number of shareholders at March 14, 2000 was 609 and the total outstanding shares was 795,515. On February 3, 2000, the Board of Directors declared a $.30 per share cash dividend payable on April 14, 2000 to shareholders of record on March 14, 2000. On January 22, 1999, the Board of Directors declared a $.20 per share cash dividend, payable on April 17, 1999 to shareholders of record on March 17, 1999. Federal regulations impose certain limitations on the payment of dividends and other capital distributions by the Bank. The Bank's ability to pay dividends is governed by the Maryland Financial Institutions Code and the regulations of the Federal Reserve Board. Under the Maryland Financial Institutions Code, a Maryland bank (1) may only pay dividends from undivided profits or, with prior regulatory approval, its surplus in excess of 100% of required capital stock and (2) may not declare dividends on its common stock until its surplus fund equals the amount of required capital stock or, if the surplus fund does not equal the amount of capital stock, in an amount in excess of 90% of net earnings. The Bank's payment of dividends is subject to the Federal Reserve Board's Regulation H, which limits the dividends payable by a state member bank to the net profits of the Bank then on hand, less the Bank's losses and bad debts. Additionally, the Federal Reserve Board has the authority to prohibit the payment of dividends by a Maryland commercial bank when it determines such payment to be an unsafe and unsound banking practice. Finally, the Bank will not pay dividends on its capital stock if its capital would thereby reduced below the remaining balance of the liquidation account established when the Bank converted from mutual to stock ownership in 1987. The Company's ability to pay dividends is governed by the policies and regulations of the Federal Reserve Board which prohibit the payment of dividends under certain circumstances involving the bank holding company's financial condition and capital adequacy. NET INCOME [GRAPH OF NET INCOME APPEARS HERE] 1995 1996 1997 1998 1999 ---- ---- ---- ---- ---- $2,027,814 $1,319,727 $2,057,204 $2,381,847 $2,153,490 [GRAPH OF TRI-COUNTY FINANCIAL CORPORATION MEASURES OF PERFORMANCE RETURN OF ASSETS APPEARS HERE] 1995 1996 1997 1998 1999 ---- ---- ---- ---- ---- 1.28% 0.77% 1.13% 1.20% 1.00% [GRAPH OF TRI-COUNTY FINANCIAL CORPORATION PORTFOLIO NET SPREAD DECEMBER 31, 1999 APPEARS HERE] Weighted average rate paid Weighted average on all on all interest-bearing interest-earning assets liabilities Net Spread ----------------------- -------------------------- ---------- 1995 8.45% 4.17% 4.28% 1996 8.25% 4.22% 4.03% 1997 8.29% 4.37% 3.92% 1998 8.15% 4.24% 3.91% 1999 7.75% 3.92% 3.83% SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
At December 31, ------------------------------------------------------------------------- 1999 1998 1997 1996 1995 ------------------------------------------------------------------------- Total Amount of: Loans Outstanding..................................... $ 147,483,466 $ 134,912,633 $ 123,565,634 $ 111,862,620 $ 107,678,852 Interest and Noninterest-bearing cash................. 6,532,583 5,059,474 5,820,753 3,903,612 4,050,219 Investment Securities................................. 60,889,772 60,121,025 55,751,720 56,783,231 46,858,152 Assets................................................ 222,897,280 206,863,119 191,188,360 178,146,326 164,124,420 Savings Deposits...................................... 155,741,800 151,815,364 142,276,077 135,534,163 130,034,043 Borrowed Money........................................ 44,798,378 33,434,332 29,201,820 24,733,466 17,552,845 Stockholders' Equity.................................. 21,115,383 20,975,295 19,086,079 17,077,452 15,832,925 Number of: Loans Outstanding..................................... 3,111 3,063 3,023 2,854 2,792 Savings Accounts...................................... 17,177 15,565 15,303 14,849 14,090 Offices Open - All Full Service....................... 9 8 8 8 6 For the Year Ended December 31, ------------------------------------------------------------------------- 1999 1998 1997 1996 1995 ------------------------------------------------------------------------- Weighted Average Yield on: Loan Portfolio........................................ 8.37 9.00% 9.20% 9.13% 9.38% Investment Portfolio.................................. 6.46 6.42 6.48 6.42 6.45 All Interest-earning Assets........................... 7.75 8.15 8.29 8.25 8.45 Weighted Average Rate Paid on: Savings Deposits and Escrow........................... 3.59 3.91 4.06 4.05 4.06 Federal Home Loan Bank Advances and Other Borrowings.. 5.33 5.72 5.91 5.46 6.21 All Interest-bearing Liabilities...................... 3.92 4.24 4.37 4.22 4.28 Interest Rate Spread (Spread between Weighted Average Rate on All Interest-earning Assets and All Interest-bearing Liabilities)................. 3.83 3.91 3.92 4.03 4.17 Net Yield (Net Interest Income as a Percentage of Average Interest-earning Assets)........ 4.11 4.21 4.23 4.32 4.46
SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA (CONTINUED)
SUMMARY OF OPERATIONS At December 31, ------------------------------------------------------------------------- 1999 1998 1997 1996 1995 ------------------------------------------------------------------------- Interest Income......................................... $ 15,853,330 $ 15,721,675 $ 14,966,454 $ 13,741,595 $ 12,900,876 Interest Expense........................................ 7,441,179 7,596,727 7,350,648 6,406,756 6,094,968 ------------------------------------------------------------------------- Net Interest Income..................................... $ 8,412,151 $ 8,124,948 $ 7,615,806 $ 7,064,839 $ 6,805,908 Loss Provision and Charge-offs of Loans................. 240,000 240,000 240,000 408,000 210,000 ------------------------------------------------------------------------- Net Interest Income After Provision for Loss on Loans..................... $ 8,172,151 $ 7,884,948 $ 7,375,806 $ 6,656,839 $ 6,595,908 Other Income............................................ 1,271,464 1,420,536 930,745 798,405 857,467 Less Noninterest Expense................................ 6,278,125 5,466,637 4,877,347 5,350,317 4,098,561 ------------------------------------------------------------------------- Income Before Federal Income Tax........................ $ 3,167,490 $ 3,838,847 $ 3,429,204 $ 2,104,927 $ 3,354,814 Income Tax Expense...................................... 1,014,000 1,457,000 1,372,000 785,200 1,327,000 Income Tax Benefit - Change in Accounting for Deferred Taxes.................................................. - - - - - ------------------------------------------------------------------------- Net Income.............................................. $ 2,153,490 $ 2,381,847 $ 2,057,204 $ 1,319,727 $ 2,027,814 ------------------------------------------------------------------------- Net Income Per Common Share (1)......................... $ 2.75 $ 3.00 $ 2.57 $ 1.65 $ 2.62 Cash Dividends Declared Per Common Share (2)............ 238,655 158,712 97,627 75,498 70,574 (1) Restated to reflect 1995, 1996, 1997, and 1998 stock dividends. (2) a $0.10 per common share cash dividend was declared on January 24, 1996, payable to shareholders of record March 4, 1996; a $0.10 per common share cash dividend was declared on January 24, 1997, payable to shareholders of record March 7, 1997; a $0.125 per common share cash dividend was declared on February 15, 1998, payable to shareholders of record March 13, 1998; a $0.20 per common share cash dividend was declared on January 22, 1999, payable to shareholders of record March 17, 1999 a $0.30 per common share cash dividend was declared on February 03, 2000, payable to shareholders of record March 14, 2000
TRI-COUNTY FINANCIAL CORPORATION REPORT ON AUDITS OF CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 No extracts from this report may be published without our written consent. Stegman & Company TABLE OF CONTENTS INDEPENDENT AUDITORS' REPORT CONSOLIDATED FINANCIAL STATEMENTS Page ---- Balance Sheets 1 Statements of Income 2 Statements of Changes in Stockholders' Equity 3 Statements of Cash Flows 4 - 5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 6 - 26 Stockholders and Board of Directors Tri-County Financial Corporation Waldorf, Maryland We have audited the accompanying consolidated balance sheets of Tri-County Financial Corporation as of December 31, 1999 and 1998, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Tri-County Financial Corporation as of December 31, 1999 and 1998, and the results of its operations and cash flows for each of the three years in the period ended December 31, 1999, in conformity with generally accepted accounting principles. /s/ Stegman & Company Baltimore, Maryland February 25, 2000 TRI-COUNTY FINANCIAL CORPORATION CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1999 AND 1998 ASSETS 1999 1998 ------------ ------------ Cash and due from banks $ 3,469,304 $ 906,658 Interest-bearing deposits with banks 3,063,279 4,152,816 Investment securities available-for-sale - at fair value 56,655,300 55,976,606 Investment securities held-to-maturity - at amortized cost 1,946,772 2,139,069 Stock in Federal Home Loan Bank and Federal Reserve Bank - at cost 2,287,700 2,005,350 Loans held for sale 773,099 2,266,697 Loans receivable - net of allowance for loan losses of $1,653,290 and $1,540,551, respectively 146,710,367 132,645,936 Premises and equipment, net 4,516,386 4,316,207 Foreclosed real estate 176,626 -- Accrued interest receivable 1,146,520 1,330,105 Other assets 2,151,927 1,123,675 ------------- ------------- TOTAL ASSETS $ 222,897,280 $ 206,863,119 ============= ============= LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Noninterest-bearing deposits $ 10,102,479 $ 9,750,153 Interest-bearing deposits 145,639,321 142,065,211 ------------- ------------- Total deposits 155,741,800 151,815,364 Short-term borrowings 13,398,378 16,937,882 Long-term debt 31,400,000 16,496,450 Accrued expenses and other liabilities 1,241,719 638,128 ------------- ------------- Total liabilities 201,781,897 185,887,824 ------------- ------------- STOCKHOLDERS' EQUITY: Common stock - par value $.01; authorized - 15,000,000 shares; issued 788,173 and 789,334 shares, respectively 7,882 7,893 Surplus 7,447,240 7,309,901 Retained earnings 14,555,324 13,215,770 Accumulated other comprehensive (loss) income (718,498) 648,614 Unearned ESOP shares (176,565) (206,883) ------------- ------------- Total stockholders' equity 21,115,383 20,975,295 ------------- ------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 222,897,280 $ 206,863,119 ============= ============= See notes to consolidated financial statements. 1 TRI-COUNTY FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 1999 1998 1997 ------------ ------------ ------------ INTEREST INCOME: Interest and fees on loans $ 11,562,846 $ 11,637,672 $ 11,029,413 Taxable interest and dividends on investment securities 4,197,132 3,941,744 3,782,205 Interest on deposits with banks 93,352 142,259 154,836 ------------ ------------ ------------ Total interest income 15,853,330 15,721,675 14,966,454 ------------ ------------ ------------ INTEREST EXPENSE: Interest on deposits 5,528,672 5,693,385 5,683,348 Interest on short term borrowings 501,644 958,119 925,084 Interest on long-term debt 1,410,863 945,223 742,216 ------------ ------------ ------------ Total interest expense 7,441,179 7,596,727 7,350,648 ------------ ------------ ------------ NET INTEREST INCOME 8,412,151 8,124,948 7,615,806 PROVISION FOR LOAN LOSSES 240,000 240,000 240,000 ------------ ------------ ------------ NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 8,172,151 7,884,948 7,375,806 ------------ ------------ ------------ NONINTEREST INCOME: Loan appraisal, credit, and miscellaneous charges 182,494 223,326 158,945 Net gains on sale of loans 238,215 416,838 240,407 Net loss on sales of investment securities (605) (391) (17,502) Service charges and fees 811,991 600,067 496,972 Other income 39,369 180,696 51,923 ------------ ------------ ------------ Total noninterest income 1,271,464 1,420,536 930,745 ------------ ------------ ------------ NONINTEREST EXPENSES: Salaries and employee benefits 3,600,119 3,114,748 2,624,131 Occupancy expense 540,667 494,113 396,378 ATM and deposit expenses 287,178 255,645 205,998 Advertising 280,044 162,133 170,116 Data processing expense 215,227 259,025 253,677 Depreciation of furniture, fixtures, and equipment 231,240 204,230 185,548 Other expenses 1,121,650 976,743 1,041,499 ------------ ------------ ------------ Total noninterest expenses 6,276,125 5,466,637 4,877,347 ------------ ------------ ------------ INCOME BEFORE INCOME TAXES 3,167,490 3,838,847 3,429,204 Income tax expense 1,014,000 1,457,000 1,372,000 ------------ ------------ ------------ NET INCOME $ 2,153,490 $ 2,381,847 $ 2,057,204 ============ ============ ============ INCOME PER COMMON SHARE: Basic income per share $ 2.75 $ 3.00 $ 2.53 Diluted income per share 2.59 2.79 2.37 See notes to consolidated financial statements. 2 TRI-COUNTY FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
Accumu- lated Other Compre- Unearned Common Paid-in Retained hensive ESOP Stock Capital Earnings Income Shares Total -------- ---------- ------------ ------------ ----------- --------- BALANCES, JANUARY 1, 1997 - as previously reported $7,510 $5,724,729 $11,430,666 $ 88,778 $(174,231) $17,077,452 Adjustment for correction of accrued interest - - (125,507) - - (125,507) ------ ------------ ----------- ----------- --------- ----------- Beginning balances, January 1, 1997 - as restated 7,510 5,724,729 11,305,159 88,778 (174,231) 16,951,945 Comprehensive income: Net income - - 2,057,204 - - 2,057,204 Unrealized gain on investment securities net of tax of $222,265 and reclassification adjustments of $16,950 - - - 353,254 - 353,254 ----------- Total comprehensive income - - - - - 2,410,458 Cash dividend - $0.10 per share - - (75,498) - - (75,498) 5% stock dividend 375 828,750 (829,125) - - - Cash paid in lieu of stock dividend for fractional shares - - (5,510) - - (5,510) Exercise of stock options 112 20,683 - - - 20,795 Repurchase of common stock (170) - (348,101) - - (348,271) Net change in unearned ESOP shares - - - - (20,154) (20,154) ------ ------------ ----------- ----------- --------- ----------- BALANCES, DECEMBER 31, 1997 7,827 6,574,162 12,104,129 442,032 (194,385) 18,933,765 Comprehensive income: Net income - - 2,381,847 - - 2,381,847 Unrealized gains on investment securities net of tax of $129,980 - - - 206,582 - 206,582 ----------- Total comprehensive income - - - - - 2,588,429 Cash dividend - $0.125 per share - - (97,627) - - (97,627) 4% stock dividend 310 693,962 (694,272) - - - Cash paid in lieu of stock dividend for fractional shares - - (4,871) - - (4,871) Exercise of stock options 58 41,777 - - - 41,835 Repurchase of common stock (200) - (473,436) - - (473,636) Net change in unearned ESOP shares (102) - - - (12,498) (12,600) ------ ------------ ----------- ----------- --------- ----------- BALANCES, DECEMBER 31, 1998 7,893 7,309,901 13,215,770 648,614 (206,883) 20,975,295 Comprehensive income: Net income - - 2,153,490 - - 2,153,490 Unrealized loss on investment securities net of tax of $770,187 - - - (1,367,112) - (1,367,112) ----------- Total comprehensive income 786,378 Cash dividend - $0.20 per share - - (157,034) - - (157,034) Excess of fair market value over cost of leveraged ESOP shares released - 11,401 - - - 11,401 Exercise of stock options 222 125,938 - - - 126,160 Repurchase of common stock (248) - (656,902) - - (657,150) Net change in unearned ESOP shares 15 - - - 30,318 30,333 ------ ------------ ----------- ----------- --------- ----------- BALANCES, DECEMBER 31, 1999 $7,882 $7,447,240 $14,555,324 $ (718,498) $(176,565) $21,115,383 ====== ============ =========== =========== ========= ===========
See notes to consolidated financial statements. 3 TRI-COUNTY FINANCIAL CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 1999 1998 1997 ----------- ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 2,153,490 $ 2,381,847 $ 2,057,204 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 240,000 240,000 240,000 Depreciation and amortization 336,383 301,238 324,134 Amortization of premium/discount on mortgage-backed securities and investments (236,443) 33,346 (50,456) Deferred income tax (benefit) (68,000) (131,000) 2,000 Decrease (increase) in accrued interest receivable 183,585 (206,043) (84,378) Decrease in deferred loan fees (122,180) (130,320) (25,905) Increase (decrease) in accrued expenses and other liabilities 690,273 14,765 (314,242) Decrease in other assets (276,747) (539,020) (219,661) Loss (gain) on disposal of premises and equipment 3,256 (66,813) 41,660 Loss on sale of investment securities 605 391 17,502 Origination of loans held for sale (9,268,298) (23,740,825) (12,562,767) Proceeds from sale of loans held for sale 11,000,111 23,589,839 12,116,232 Gain on sales of loans (238,215) (416,839) (240,407) Gain on sale of foreclosed real estate -- (61,654) (7,000) ------------ ------------ ------------ Net cash provided by operating activities 4,397,820 1,268,912 1,293,916 ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Net decrease (increase) in interest-bearing deposits with banks 1,089,537 1,017,014 (2,378,112) Purchase of investment securities available-for-sale (74,254,708) (90,192,914) (47,628,227) Proceeds from sale, redemption or principal payments of investment securities available-for-sale 71,673,801 87,391,528 49,084,708 Purchase of investment securities held-to-maturity (1,697,520) (3,110,963) (189,525) Proceeds from maturities or principal payments of investment securities held-to-maturity 1,890,569 2,127,218 797,119 Net purchase of FHLB stock and Federal Reserve Bank stock (282,350) (281,350) (424,000) Loans originated or acquired (62,475,059) (54,084,255) (53,126,555) Principal collected on loans 48,239,092 42,431,995 41,896,388 Purchase of premises and equipment (551,968) (478,661) (680,078) Proceeds from sales of premises and equipment 12,150 117,251 -- Proceeds from disposition of foreclosed real estate -- 825,060 162,135 Acquisition from foreclosed real estate (122,910) -- -- ------------ ------------ ------------ Net cash used in investing activities (16,479,366) (14,238,077) (12,486,147) ------------ ------------ ------------ 4 Tri-County Financial Corporation Consolidated Statements of Cash Flows (Continued) For the Years Ended December 31, 1999, 1998 and 1997
1999 1998 1997 ------------- ------------ ------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposits $ 3,926,436 $ 9,539,287 $ 6,741,914 Net (decrease) increase in short-term borrowings (3,539,504) 4,414,672 (746,749) Dividends paid (157,034) (102,498) (81,008) Exercise of stock options 126,160 41,835 20,795 Net change in unearned ESOP shares 41,734 (12,600) (20,154) Repurchase of common stock (657,150) (473,636) (348,271) Proceeds from long-term debt 35,000,000 - 22,400,000 Payments of long-term debt (20,096,450) (182,160) (17,235,267) ------------ ----------- ------------ Net cash provided by financing activities 14,644,192 13,224,900 10,731,260 ------------ ----------- ------------ INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2,562,646 255,735 (460,971) CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR 906,658 650,923 1,111,894 ------------ ----------- ------------ CASH AND CASH EQUIVALENTS AT END OF YEAR $ 3,469,304 $ 906,658 $ 650,923 ============ =========== ============ Supplementary cash flow information: Cash paid during the year for: Interest $ 7,368,462 $ 7,942,034 $ 7,284,916 Income taxes 1,288,882 1,502,868 1,625,000 Transfers from loans receivable to foreclosed real estate 53,716 763,406 -
See notes to consolidated financial statements. 5 TRI-COUNTY FINANCIAL CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation --------------------------- The consolidated financial statements include the accounts of Tri- County Financial Corporation and its wholly owned subsidiary, Community Bank of Tri-County (the Bank) and the Bank's wholly owned subsidiaries, Tri-County Investment Corporation and Tri-County Federal Finance One (collectively, "the Company"). All significant intercompany balances and transactions between the parent corporations and their subsidiaries have been eliminated. The accounting and reporting policies of the Company conform with generally accepted accounting principles and to general practices within the banking industry. Certain reclassifications have been made to amounts previously reported to conform with classifications made in 1999. Nature of Operations -------------------- The Company, through its bank subsidiary, conducts full service commercial banking operations throughout the Southern Maryland area. The primary financial services provided include mortgage loans on residential, construction and commercial real estate and various types of consumer lending as well as offering demand deposits and savings products. Use of Estimates ---------------- The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Cash and Cash Equivalents ------------------------- For purposes of the consolidated statements of cash flows, the Company considers all highly liquid debt instruments with original maturities when purchased of three months or less to be cash equivalents. These instruments are presented as cash and due from banks. 6 Investment Securities --------------------- Investment securities are classified into the following three categories: trading, held-to-maturity, and available-for-sale. Trading securities are purchased and held principally for the purpose of reselling them within a short period of time. Their unrealized gains and losses are included in noninterest income. Securities classified as held-to-maturity are reported at amortized cost, and require the Company to have both the positive intent and ability to hold those securities to maturity. Securities not classified as either trading or held-to-maturity are considered to be available-for-sale. Unrealized holding gains and losses on available-for-sale securities are excluded from earnings and reported as accumulated other comprehensive income, a separate component of stockholders' equity, net of deferred taxes, until realized. Realized gains or losses on the sale of investment securities are recognized at the time of sale using the specific identification method and are classified as noninterest income in the accompanying consolidated statements of income. The Company invests in Federal Home Loan Bank and Federal Reserve Bank stock which are considered restricted as to marketability. Loans Receivable ---------------- Loans - Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal reduced by any charge-offs or specific valuation allowance accounts and any deferred fees or costs on originated loans. Loans Held for Sale - Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value, determined in the aggregate. Market value considers commitment agreements with investors and prevailing market prices. A gain is recognized on the sale of these loans through collection of a premium over the adjusted carrying value, and through retention of an on-going rate differential as a normal servicing fee between the rate paid by the borrower to the Company and the rate paid by the Company to the purchaser. Income Recognition on Loans - Interest on commercial loans, real estate mortgages, and certain installment loans is accrued at the contractual rate on the principal amounts outstanding. When scheduled principal or interest payments are past due 90 days or more on any loan not fully secured by collateral and not in the process of collection, the accrual of interest income is discontinued and recognized only as collected. The loan is restored to an accruing status when all amounts past due have been paid and the borrower has demonstrated the ability to service the debt on a current basis. Loan fees and related direct costs of loan origination are deferred and recognized over the life of the loan as a component of interest income. Allowance for Loan Losses - The allowance for loan losses is maintained at a level believed by management to be adequate to absorb potential losses inherent in the loan portfolio. Management's determination of the adequacy of the allowance is based on a periodic evaluation of the portfolio with consideration given to the overall loss experience; current economic conditions; volume, growth, and composition of the loan portfolio; financial condition of the borrowers; and other relevant factors that, in management's judgment, warrant recognition in providing an adequate allowance. The allowance is increased by provisions for loan losses charged against income and decreased by charge-offs (net of recoveries). Changes in the allowance are recorded periodically as conditions change or as more information becomes available. Such changes could result in material adjustments to future results of operations. 7 Impairment of Loans - The Company evaluates its loan portfolios for impairment. When deemed necessary, a valuation allowance is provided for these loans based on management's estimates of the risks inherent in the portfolios and analysis of prior loss experiences. Payments received relating to impaired loans and nonaccrual loans are recorded on a cash basis and are either applied to the outstanding principal balance or recorded as interest income, depending upon management's assessment of the ultimate collectibility of the loan. Premises and Equipment ---------------------- Depreciation of premises and equipment, which are carried at cost, is provided by the straight-line method over the estimated useful lives as follows: Buildings and improvements 15 - 50 years Furniture and equipment 5 - 15 years Automobiles 5 years Foreclosed Real Estate ---------------------- Real estate acquired through, or in lieu of, loan foreclosure is initially recorded at the lower of the recorded investment or fair value at the date of foreclosure. Costs relating to the development and improvement of property are capitalized, whereas costs relating to the holding of property are expensed. Valuations are periodically performed by management and an allowance for losses is established by a charge to operations if the carrying value of a property exceeds its estimated fair value less estimated costs to sell. No charge to operations was required as a result of this review in 1999, 1998 or 1997. Mortgage Servicing Rights ------------------------- The rights to service certain mortgages, including those purchased as well as originated, are amortized in proportion to and over the estimated period of the related net servicing revenues and are evaluated for impairment based on their fair value. Total capitalized mortgage servicing rights approximated $586,000 and $546,000 at December 31, 1999 and 1998, respectively. Income Taxes ------------ The Company files a consolidated federal income tax return with its subsidiaries. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Any deferred tax asset is reduced by the amount of any tax benefit that more likely than not will not be realized. 8 Income Per Common Share ----------------------- Basic net income per common share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the year. Diluted net income per common share is computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding during the year including any potential dilutive common shares outstanding, such as options and warrants. Stock-Based Compensation ------------------------ Stock-based compensation is recognized using the intrinsic value method. For disclosure purposes, pro forma net income and earnings per share effects are provided as if the fair value method had been applied. New Accounting Standards ------------------------ Statement of Financial Accounting Standards No. 133 ("SFAS No. 133"), Accounting for Derivative Instruments and Hedging Activities, as amended by SFAS No. 137, Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133, requires derivative instruments be carried at fair value on the balance sheet. The statement continues to allow derivative instruments to be used to hedge various risks and sets forth specific criteria to be used to determine when hedge accounting can be used. The statement also provides for offsetting changes in fair value or cash flows of both the derivative and the hedged asset or liability to be recognized in earnings in the same period; however, any changes in fair value or cash flow that represent the ineffective portion of a hedge are required to be recognized in earnings and cannot be deferred. For derivative instruments not accounted for as hedges, changes in fair value are required to be recognized in earnings. The Company plans to adopt the provisions of this statement, as amended, for its quarterly and annual reporting beginning January 1, 2001, the statement's effective date. The effect of adopting the provisions of this statement on the Company's financial position, results of operations and cash flows subsequent to the effective date is not currently estimable and will depend on the financial position of the Company and the nature and purpose of any derivative instruments in use at that time. Prior Period Restatement ------------------------ In December 1999, management discovered an error in its method of calculating accrued interest on mortgage loans. This error resulted in the Bank recording interest earned on certain loans which had been sold to participants. The effect of correcting this error was a reduction in retained earnings as of January 1, 1997 in the amount of $125,507 (net of $78,968 in taxes). The correction is reflected in the accompanying financial statements as a reduction of 1998 and 1997 net income of $4,357 (net of $2,741 in taxes) and $26,807 (net of $16,867 in taxes), respectively. 9 1998 1997 -------------- -------------- Net income: As initially reported $2,386,204 $2,084,011 As corrected 2,381,847 2,057,204 Basic earnings per share: As initially reported $ 3.00 $2.57 As corrected 3.00 2.53 Diluted earnings per share: As initially reported $ 2.80 2.40 As corrected 2.79 2.37 2. INVESTMENT SECURITIES AVAILABLE-FOR-SALE The amortized cost and estimated fair values of investment securities available-for-sale are as follows:
December 31, 1999 --------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------- ---------- ---------- ----------- Corporate equity securities $ 511,206 $ 239,890 $ - $ 751,096 Money Market and mutual funds 820,125 - - 820,125 Obligations of U.S. Government Agencies and U.S. Government Sponsored Enterprises (GSE's) 8,000,000 - 381,073 7,618,927 Asset-backed securities issued by: GSE's 30,213,481 102,799 815,203 29,501,077 Other 18,191,069 42,643 269,637 17,964,075 ----------- ---------- ---------- ----------- $57,735,881 $ 385,332 $1,465,913 $56,655,300 =========== ========== ========== =========== December 31, 1998 --------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ----------- ---------- ---------- ----------- Corporate equity securities $ 763,166 $ 458,123 $ - $ 1,221,289 Money Market and mutual funds 292,502 - - 292,502 Obligations of U.S. Government Agencies and U.S. Government Sponsored Enterprises (GSE's) 9,000,000 53,215 8,260 9,044,955 Asset-backed securities issued by: GSE's 31,340,373 465,934 82,336 31,723,971 Other 13,523,847 171,792 1,750 13,693,889 ----------- ---------- ---------- ----------- $54,919,888 $1,149,064 $ 92,346 $55,976,606 =========== ========== ========== ===========
10 The scheduled maturities of investment securities available-for-sale at December 31, 1999 are as follows: Available-for-Sale --------------------------- Estimated Amortized Fair Cost Value -------------- ----------- Due in one year or less $ 5,331,331 $ 5,441,579 Due after one year through five years 4,000,000 3,748,569 Asset-backed securities 48,317,335 47,465,152 ----------- ----------- 57,648,666 $56,655,300 =========== =========== Sales of investment securities available-for-sale during 1999, 1998 and 1997 resulted in the following: 1999 1998 1997 -------- -------- ---------- Proceeds $200,000 $408,500 $3,369,000 Gross gains - - 2,111 Gross losses (605) (391) (19,613) Asset-backed securities are comprised of mortgage-backed securities as well as mortgage derivatives such as collateralized mortgage obligations and real estate mortgage investment conduits. The outstanding balance of no single issuer, except for U.S. Government-Sponsored Enterprise Securities, exceeded five percent of the Company's stockholders' equity at December 31, 1999 and 1998. 3. INVESTMENT SECURITIES HELD-TO-MATURITY The amortized cost and estimated fair values of investments held-to- maturity are as follows: December 31, 1999 ---------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gains Losses Value ---------- ---------- ---------- ---------- Obligations of U.S. Government Agencies $ 197,719 $ - $ - $ 197,719 Other investments 1,749,053 - - 1,749,053 ---------- ---------- ---------- ---------- $1,946,772 $ - $ - $1,946,772 ========== ========== ========== ========== 11 December 31, 1998 ------------------------------------------------- Gross Gross Estimated Amortized Unrealized Unrealized Fair Cost Gain Losses Value ---------- ---------- ------------ ----------- Obligations of U.S. Government Agencies $ 196,967 $ - $ - $ 196,967 Asset-backed securities 544,696 19,966 - 564,662 Other investments 1,397,406 - - 1,397,406 ---------- ---------- ---------- ---------- $2,139,069 $ 19,966 $ - $2,159,035 ========== ========== ========== ========== 4. LOANS RECEIVABLE Loans receivable at December 31, 1999 and 1998 consist of the following: 1999 1998 ---------- ---------- Commercial real estate $ 29,947,350 $ 19,732,432 Residential real estate 66,263,457 64,243,146 Residential construction 17,142,072 20,776,294 Second mortgage loans 16,691,345 16,313,728 Lines of credit - commercial 10,024,782 6,161,033 Consumer loans 9,102,409 7,889,792 ------------ ------------ 149,171,415 135,116,425 ------------ ------------ Less: Deferred loan fees 807,758 929,938 Allowance for loan losses 1,653,290 1,540,551 ------------ ------------ 2,461,048 2,470,489 ------------ ------------ Total $146,710,367 $132,645,936 ============ ============ The following table sets forth the activity in the allowance for loan losses: 1999 1998 1997 ---------- ---------- ---------- Balance, January 1 $1,540,551 $1,310,365 $1,120,102 Add: Provision charged to operations 240,000 240,000 240,000 Recoveries 6,790 275 105 Less: Charge-offs 134,051 10,089 49,842 ---------- ---------- ---------- Balance, December 31 $1,653,290 $1,540,551 $1,310,365 ========== ========== ========== 12 No loans included within the scope of SFAS 114 were identified as being impaired at December 31, 1999 or 1998 and for the years then ended. Loans on which the recognition of interest has been discontinued, which were not included within the scope of SFAS 114, amounted to approximately $218,000, $269,000, and $160,000 at December 31, 1999, 1998, and 1997, respectively. If interest income had been recognized on nonaccrual loans at their stated rates during 1999, 1998, and 1997, interest income would have been increased by approximately $27,001, $21,000, and $29,000, respectively. No income was recognized for these loans in 1999, 1998 and 1997. Included in loans receivable at December 31, 1999 and 1998, is $1,379,274 and $1,347,263 due from officers and directors of the Bank. Activity in loans outstanding to officers and directors is summarized as follows: 1999 1998 ----------- ----------- Balance, beginning of year $1,347,263 $1,206,615 New loans made during year 908,424 226,547 Repayments made during year (876,413) (85,899) ---------- ---------- Balance, end of year $1,379,274 $1,347,263 ========== ========== Loans serviced for others and not reflected in the balance sheets are $61,992,725 and $56,040,000 at December 31, 1999 and 1998, respectively. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors and foreclosure processing. Loan servicing income is recorded on the accrual basis and includes servicing fees from investors and certain charges collected from borrowers, such as late payment fees. The Bank grants loans throughout the Southern Maryland area. Its borrowers' ability to repay is, therefore, dependent upon the economy of Southern Maryland. 5. PREMISES AND EQUIPMENT A summary of premises and equipment at December 31, 1999 and 1998 is as follows: 1999 1998 ---------- ---------- Cost: Land $1,439,224 $1,437,761 Building and improvements 2,964,425 2,769,246 Furniture and equipment 2,133,436 1,810,221 Automobiles 103,144 105,394 ---------- ---------- Total cost 6,640,229 6,122,622 Less accumulated depreciation 2,123,843 1,806,415 ---------- ---------- Premises and equipment, net $4,516,386 $4,316,207 ========== ========== 13 Certain bank facilities are leased under various operating leases. Rent expense was $175,949, $161,167 and $118,556 in 1999, 1998 and 1997, respectively. Future minimum rentals commitments under noncancellable leases are as follows: 2000 $ 154,906 2001 130,534 2002 133,859 2003 125,124 2004 125,124 Thereafter 373,423 ---------- Total $1,042,970 ========== 6. DEPOSITS Deposits outstanding at December 31 consist of: 1999 1998 ------------ ------------ Noninterest-bearing demand $ 10,102,479 $ 9,750,153 ------------ ------------ Interest-bearing: Demand 19,041,881 16,963,000 Money market deposits 34,669,161 20,775,000 Savings 21,427,279 25,771,211 Certificates of deposit of $100,000 or more 13,734,000 12,989,000 Other certificates of deposit 56,767,000 65,567,000 ------------ ------------ Total interest-bearing 145,639,321 142,065,211 ------------ ------------ Total deposits $155,741,800 $151,815,364 ============ ============ 7. ADVANCES FROM THE FEDERAL HOME LOAN BANK OF ATLANTA AND OTHER BORROWINGS The advances from the Federal Home Loan Bank are as follows: Weighted Average Interest Year Due Rate Amount ---------- --------- ----------- 2000 5.65 $13,000,000 2002 6.51 11,400,000 2004 5.03 10,000,000 2009 4.95 10,000,000 ----------- $44,400,000 =========== 14 Under the terms of an Agreement for Advances and Security Agreement with Blanket Floating Lien, the Company maintains eligible collateral consisting of 1-4 unit residential first mortgage loans, discounted at 75% of the unpaid principal balance, equal to 100% at December 31, 1999 and 1998, of its outstanding Federal Home Loan Bank advances. These amounts were $59,200,000 and $43,900,000 at December 31, 1999 and 1998, respectively. The advances due in 2002 have call provisions under which the Federal Home Loan Bank may require payment prior to the stated maturity date. Until July 1999, when the liability was paid off, Tri-County Federal Finance One (Finance One) was obligated on a note payable issued in connection with its participation in the Salomon Capital Access Collateralized Mortgage Obligation Bond Program. Under this program, Finance One pledged Federal Home Loan Mortgage Corporation participation certificates having unpaid principal balances at December 31, 1998 totaling $544,696 as security for the notes. The participation certificates were held in trust, and the principal and interest payments required by the note payable were made out of the monthly cash proceeds from the certificates. The maturity date and interest rate, which were subject to adjustment based on prepayments of the participation certificates, for the notes payable at December 31, 1999 and 1998, are as follows: Unpaid Principal (Net of Discount) December 31, -------------------- Interest Maturity 1999 1998 Rate Date ------- -------- -------- -------- $ - $96,450 N/A N/A The Company enters into sales of securities under agreements to repurchase with terms to maturity of less than one month and short-term borrowings from the Federal Home Loan Bank. The repurchase agreements are treated as financings, and the obligations to repurchase securities sold are reflected as a liability in the balance sheets. The dollar amounts of securities underlying the agreements remain in the asset accounts. The securities underlying the agreements are book-entry securities and were delivered by appropriate entry into the counterparties' accounts maintained at the purchasing securities dealer's safekeeping house. The repurchase agreements subject the Company to the risk that its interest in the sold securities is inadequately protected in the event the purchasing securities dealer fails to perform its obligations. The Company attempts to reduce the effects of such risks by entering into such agreements only with well-capitalized securities dealers who are primary dealers in government securities and by limiting the maximum amount of agreements outstanding at any time with any single securities dealer. Additional information regarding short-term borrowings and repurchase agreements is as follows: 1999 1998 ------------ ------------ Balance outstanding at December 31 $13,398,378 $16,937,882 Average balance during the year 9,449,297 16,743,325 Average interest rate during the year 5.53% 5.72% Maximum outstanding balance at any month end during the year 16,806,734 26,619,724 15 Other borrowed funds consist of treasury tax and loan deposits that generally mature within one to 120 days from the transaction date. At December 31, 1999 and 1998, such borrowings were $398,378 and $437,882, respectively. The aggregate scheduled principal maturities on all borrowings outstanding at December 31, 1999 are as follows: 2000 $13,398,378 2002 11,400,000 2004 10,000,000 2009 10,000,000 ----------- Total $44,798,378 =========== 8. INCOME TAXES Income tax expense was as follows: 1999 1998 1997 ----------- ----------- ---------- Current: Federal $ 973,000 $ 1,317,000 $ 1,122,000 State 109,000 271,000 248,000 ----------- ----------- ----------- 1,082,000 1,588,000 1,370,000 ----------- ----------- ----------- Deferred: Federal (56,000) (107,000) 1,600 State (12,000) (24,000) 400 ----------- ----------- ----------- (68,000) (131,000) 2,000 ----------- ----------- ----------- Total income tax expense $ 1,014,000 $ 1,457,000 $ 1,372,000 =========== =========== =========== Total income tax expense differed from the amounts computed by applying the federal income tax rate of 34% to income before income taxes as a result of the following:
1999 1998 1997 ----------------------- ----------------------- ---------------------- Percent of Percent of Percent of Pretax Pretax Pretax Amount Income Amount Income Amount Income ----------- ---------- ----------- ---------- ---------- ---------- Expected income tax expense at federal tax rate $1,077,000 34.0% $1,307,000 34.0% $1,175,000 34.0% State taxes, net of federal benefit 62,000 2.0 178,000 4.6 154,000 4.5 Nondeductible expenses 14,000 .4 5,400 .1 5,000 .1 Deduction for stock options exercised (90,000) (2.9) - .0 - .0 Other (49,000) (1.5) (33,400) (.8) 38,000 1.1 ---------- ---- ---------- ---- ---------- ---- Total income tax expense $1,014,000 32.0% $1,457,000 37.9% $1,372,000 39.7% ========== ==== ========== ==== ========== ====
16 The net deferred tax assets (liabilities) in the accompanying balance sheets include the following components: 1999 1998 -------- ---------- Deferred tax assets: Deferred fees $ 74,199 $ 119,091 Allowance for loan losses 423,906 327,407 Deferred compensation 78,168 58,982 Unrealized loss on investment securities available-for-sale 362,083 - -------- --------- Total deferred assets 938,356 505,480 -------- --------- Deferred tax liabilities: FHLB stock dividends 152,896 152,896 Depreciation 83,633 80,840 Unrealized gain on investment securities available-for-sale - 408,104 -------- --------- Total deferred liabilities 236,529 641,840 -------- --------- Net deferred assets (liabilities) $701,827 $(136,360) ======== ========= Retained earnings at December 31, 1999, include approximately $1.2 million of bad debt deductions allowed for federal income tax purposes (the "base year tax reserve") for which no deferred income tax has been recognized. If, in the future, this portion of retained earnings is used for any purpose other than to absorb bad debt losses, it would create income for tax purposes only and income taxes would be imposed at the then prevailing rates. The unrecorded income tax liability on the above amount was approximately $458,000 at December 31, 1999. Prior to January 1, 1996, the Bank computed its tax bad debt deduction based upon the percentage of taxable income method as defined by the Internal Revenue Code. The bad debt deduction allowable under this method equaled 8% of taxable income determined without regard to the bad debt deduction and with certain adjustments. The tax bad debt deduction differed from the bad debt expense used for financial accounting purposes. In August 1996, the Small Business Job Protection Act (the "Act") repealed the percentage of taxable income method of accounting for bad debts effective for years beginning after December 31, 1995. The Act required the Bank to change its method of computing reserves for bad debts to the experience method. This method is available to banks with assets less than $500 million and allows the Bank to maintain a tax reserve for bad debts and to take bad debt deductions for reasonable additions to the reserve. As a result of this change, the Bank has to recapture into income a portion of its existing tax bad debt reserve. This recapture occurs ratably over a six-taxable year period, beginning with the 1998 tax year. For financial reporting purposes, this recapture does not result in additional tax expense as the Bank adequately provided deferred taxes in prior years. Furthermore, this change does not require the Bank to recapture its base year tax reserve. 17 9. COMMITMENTS AND CONTINGENCIES The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its borrowers. These financial instruments are commitments to extend credit. These instruments may, but do not necessarily, involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instrument is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments as it does for on-balance sheet loans receivable. As of December 31, 1999 and 1998, in addition to the undisbursed portion of loans receivable of approximately $3,763,000 and $4,353,000, respectively, the Company had outstanding loan commitments approximating $530,512 and $1,713,949 as of December 31, 1999 and 1998, respectively. These commitments are normally met from deposit account growth, loan payments, excess liquidity, or borrowed money. Standby letters of credit written are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. These guarantees are issued primarily to support construction borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds cash or a secured interest in real estate as collateral to support those commitments for which collateral is deemed necessary. Standby letters of credit outstanding amounted to $5,556,000 and $4,397,000 at December 31, 1999 and 1998, respectively. 10. PENSION PLAN On May 28, 1997, the Board of Directors, after due consideration of the projected cost of the Company's defined benefit pension plan, voted to terminate the Plan effective August 31, 1997. The present value of current benefits, plus any remaining pension assets, net of costs, were transferred into the Company's 401(k) plan on behalf of all defined benefit plan participants. The final benefit to the Company resulting from this plan curtailment was determined to be $104,653 by the plan administrator. This credit is reflected in the 1997 salaries and employee benefits in the accompanying financial statements. 18 Net pension cost for the Company's plan consists of the following: 1999 1998 1997 ------- --------- ----------- Service cost $ - $ - $ 49,239 Interest cost - - 71,313 Actual return on plan assets - - (76,268) All other components - - (6,618) Charge resulting from plan curtailment - - 73,314 Credit resulting from plan settlement - - (215,633) ------- --------- --------- Net pension (credit) cost $ - $ - $(104,653) ======= ========= ========= Assumptions used to develop the net periodic pension cost were: 1999 1998 1997 ------- --------- --------- Discount rate N/A N/A 7.5% Expected long-term rate of return on plan assets N/A N/A 8.0% Rate of increase in compensation levels N/A N/A 5.0% 11. STOCK OPTION AND INCENTIVE PLAN The Company has a stock option and incentive plan to attract and retain personnel and provide incentive to employees to promote the success of the business. At December 31, 1999, 120,946 shares of stock have been authorized for grants of options for this plan. There were no options granted during 1997. The following table provides the pro forma disclosures: 1999 1998 ---------- ---------- Net income As reported $2,153,490 $2,386,204 Pro forma 1,990,645 2,284,225 Basic earnings per share As reported 2.75 3.00 Pro forma 2.54 2.88 Diluted earnings per share As reported 2.59 2.79 Pro forma 2.39 2.68 For the purpose of computing the pro forma amounts indicated above, the fair value of each option on the date of grant is estimated using the Black- Scholes pricing model with the following weighted-average assumptions used for the grants: 1999 1998 ------- ------- Dividend yield 0.75% 0.50% Expected volatility 15.00% 15.00% Risk-free interest rate 5.72% 4.97% Expected lives (in years) 10 10 Weighted average fair value $11.51 $10.20 19 Substantially all options are 100% vested when granted, and all options expire after 10 years. The following tables summarize activity in the plan:
1999 1998 1997 --------------------- ------------------ ------------------ Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price --------- ----------- -------- --------- --------- -------- Outstanding at beginning of year 101,818 $12.61 85,566 $ 9.19 97,464 $8.56 Granted 14,143 25.24 22,006 24.18 - - Exercised (24,369) 7.61 (7,627) 7.08 (11,898) 5.69 Recission of exercise - - 1,873 6.50 - - Forfeitures (408) 26.60 - - - - -------- ------- -------- Outstanding at end of year 91,184 15.85 101,818 12.61 85,566 9.19 ======== ======= ========
Options Outstanding Options Exercisable ------------------------ ------------------------ Weighted Weighted Number Remaining Number Average Outstanding Contractual Exercisable Exercise 12/31/99 Life 12/31/99 Price ----------- ----------- ----------- --------- 55,693 6 years 55,693 6 years 1,006 8 years 1,006 8 years 28,736 9 years 28,736 9 years 5,749 10 years 5,749 10 years 12. EMPLOYEE BENEFIT PLANS The Bank has an Employee Stock Ownership Plan (ESOP) that acquires stock of the Bank's parent corporation, Tri-County Financial Corporation. The Company accounts for its ESOP in accordance with AICPA Statement of Position 93-6. Accordingly, unencumbered shares held by the ESOP are treated as outstanding in computing earnings per share. Shares issued to the ESOP but pledged as collateral for loans obtained to provide funds to acquire the shares are not treated as outstanding in computing earnings per share. Dividends on ESOP shares are recorded as a reduction of retained earnings. The ESOP may acquire in the open market up to 195,700 shares. At December 31, 1999, the Plan owns 60,035 shares. The Company also has a 401(k) plan. Employee contributions are matched by the Bank at a ratio determined annually by the Board of Directors, currently one-half of an employee's 6% elective deferral. All employees who have completed one year of service and have reached the age of 21 are covered under these defined contribution plans. Contributions are determined at the discretion of management and the Board of Directors. For the years ended December 31, 1999, 1998, and 1997, the Company charged $342,000, $186,000 and $102,000, against earnings to fund the Plans. 20 13. STOCK DIVIDENDS On February 3, 2000, the Board of Directors declared a $.30 per share cash dividend to be distributed April 14, 2000 to holders of record March 14, 2000. On January 22, 1999, the Board of Directors declared a $.20 per share cash dividend which was distributed April 17, 2000 to holders of record March 17, 2000. On February 15, 1998, the Board of Directors declared a 4% stock dividend and a $.125 per share cash dividend that was distributed on April 13, 1998 to holders of record on March 13, 1998. The stock distribution increased the Corporation's issued stock by approximately 31,000 shares. 14. REGULATORY MATTERS The Company and the Bank are subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's and the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of tangible and core capital (as defined in the regulations) to total adjusted assets (as defined), and of risk-based capital (as defined) to risk-weighted assets (as defined). Management believes, as of December 31, 1999, that the Company and the Bank meet all capital adequacy requirements to which they are subject. As of December 31, 1999, the most recent notification from the Federal Reserve categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Company's or the Bank's category. 21 The Company's and the Bank's actual capital amounts and ratios for 1999 and 1998 are presented in the tables below: (dollar amounts in thousands) To be Considered Well Capitalized Required for Under Prompt Capital Adequacy Corrective Action Actual Purposes Provisions --------------- ----------------- ------------------ Amount Ratio Amount Ratio Amount Ratio ------- ------ -------- ------- --------- ------- At December 31, 1999: Total capital (to risk- weighted assets): The Company $23,486 17.23% $10,906 8.0% The Bank 22,936 16.82% 10,906 8.0% $13,633 10.0% Tier 1 capital (to risk- weighted assets): The Company 21,833 16.02% 5,453 4.0% The Bank 21,283 15.61% 5,453 4.0% 8,179 6.0% Tier 1 capital (to average assets): The Company 21,833 9.86% 8,857 4.0% The Bank 21,283 9.61% 8,857 4.0% 11,072 5.0% At December 31, 1998: Total capital (to risk- weighted assets): The Company 22,023 18.27% 9,640 8.0% The Bank 21,791 18.08% 9,640 8.0% 12,050 10.0% Tier 1 Capital (to risk- weighted assets): The Company 20,483 17.00% 4,820 4.0% The Bank 20,251 16.80% 4,820 4.0% 7,230 6.0% Tier 1 Capital (to average assets): The Company 20,483 10.28% 7,964 4.0% The Bank 20,251 10.17% 7,964 4.0% 6,025 5.0% 22 15. EARNINGS PER SHARE The calculations of basic and diluted earnings per share are as follows: 1999 1998 1997 ---------- ---------- ---------- Basic earnings per share: Net income $2,153,490 $2,381,847 $2,057,204 Average common shares outstanding 782,950 793,458 811,694 Net income per common share - basic $ 2.75 $ 3.00 $ 2.53 Diluted earnings per share: Net income 2,153,490 2,381,847 2,057,204 Average common shares outstanding 782,950 793,458 811,694 Stock option adjustment 49,333 59,687 55,809 Average common shares outstanding - diluted 832,283 853,145 867,503 Net income per common share - diluted $ 2.59 $ 2.79 $ 2.37 16. FAIR VALUE OF FINANCIAL INSTRUMENTS The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methodologies. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company could realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. Therefore, any aggregate unrealized gains or losses should not be interpreted as a forecast of future earnings or cash flows. Furthermore, the fair values disclosed should not be interpreted as the aggregate current value of the Company.
December 31, 1999 December 31, 1998 --------------------------- --------------------------- Estimated Estimated Carrying Fair Carrying Fair Amount Value Amount Value ------------ ------------ ------------ ------------ Assets: Cash and cash equivalents $ 3,469,304 $ 3,469,304 $ 906,658 $ 906,658 Interest-bearing deposits with banks 3,063,279 3,063,279 4,152,816 4,152,816 Investment securities and stock in FHLB and FRB 61,883,138 60,889,772 60,121,025 60,140,991 Loans receivable, net 146,710,367 146,978,389 132,645,936 134,181,574 Loans held for sale 773,099 773,099 2,266,697 2,266,697 Liabilities: Savings, NOW and money market accounts 84,530,443 84,530,443 73,259,364 73,259,364 Time certificates 70,501,000 70,439,300 78,556,000 78,085,030 Long-term debt and other borrowed funds 44,798,378 46,058,410 33,434,332 33,367,035
At December 31, 1999 and 1998, the Company had outstanding loan commitments and standby letters of credit of $5.5 million and $6.1 million, respectively. Based on the short-term lives of these instruments, the Company does not believe that the fair value of these instruments differs significantly from their carrying values. 23 Valuation Methodology --------------------- Cash and Cash Equivalents - For cash and cash equivalents, the carrying amount is a reasonable estimate of fair value. Investment Securities - Fair values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Mortgage-Backed Securities - Fair values are based on quoted market prices or dealer quotes. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities. Loans Receivable and Loans Held for Sale - For conforming residential first-mortgage loans, the market price for loans with similar coupons and maturities was used. For nonconforming loans with maturities similar to conforming loans, the coupon was adjusted for credit risk. Loans which did not have quoted market prices were priced using the discounted cash flow method. The discount rate used was the rate currently offered on similar products. Loans priced using the discounted cash flow method included residential construction loans, commercial real estate loans, and consumer loans. The estimated fair value of loans held for sale is based on the terms of the related sale commitments. Deposits - The fair value of checking accounts, saving accounts, and money market accounts was the amount payable on demand at the reporting date. Time Certificates - The fair value was determined using the discounted cash flow method. The discount rate was equal to the rate currently offered on similar products. Long-Term Debt and Other Borrowed Funds - These were valued using the discounted cash flow method. The discount rate was equal to the rate currently offered on similar borrowings. The fair value estimates presented herein are based on pertinent information available to management as of December 31, 1999 and 1998. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purpose of these financial statement since that date and, therefore, current estimates of fair value may differ significantly from the amount presented herein. 24 18. CONDENSED FINANCIAL STATEMENTS - PARENT COMPANY ONLY Condensed Balance Sheets: ASSETS 1999 1998 ---------- ------------- Cash - noninterest-bearing $ 151 $ 3,044 Cash - interest-bearing 719,068 41,891 Accounts receivable 40,247 11,734 Investment securities available-for-sale 28,002 224,970 Investment in wholly owned subsidiary 20,564,441 20,743,289 ----------- ----------- TOTAL ASSETS $21,351,909 $21,024,928 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities $ 236,526 $ 49,633 Stockholders' equity: Common stock 7,882 7,893 Surplus 5,968,801 7,309,901 Retained earnings 16,033,763 13,215,770 Unearned ESOP shares (176,565) (206,883) Accumulated other comprehensive income (718,498) 648,614 ----------- ------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $21,351,909 $21,024,928 =========== ============= Condensed Statements of Income: Year Ended December 31, --------------------------------------- 1999 1998 1997 ----------- ----------- ------------ Dividends from subsidiary $ 1,000,000 $ 750,000 $ -- Interest income 42,675 13,882 41,879 Loss on sale of investment securities (605) (391) (250) Amortization and miscellaneous expenses (97,844) (76,671) (72,323) ----------- ---------- ---------- Income (loss) before income taxes and equity in undistributed net income of subsidiary 944,226 686,820 (30,694) Federal and state income tax benefit 21,000 10,350 10,436 Equity in undistributed net income of subsidiary 1,188,264 1,684,677 2,077,462 ----------- ---------- ---------- NET INCOME $ 2,153,490 $2,381,847 $2,057,204 =========== ========== ========== 25 Condensed Statements of Cash Flows:
1999 1998 1997 ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 2,153,490 $ 2,381,847 $ 2,057,204 Adjustments to reconcile net income to net cash provided by operating activities: Increase in investment in wholly owned subsidiary (1,188,264) (1,684,677) (2,087,898) Loss on sale of investment securities 605 391 250 Amortization of discount on investments - - (25,140) Increase in current assets (28,513) (10,350) - Increase in current liabilities 186,893 9,696 273 ----------- ----------- ----------- Net cash provided (used) by operating activities 1,124,211 696,907 (55,311) ----------- ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Net (increase) decrease interest-bearing deposits (677,177) 77,829 7,103 Purchase of investment securities available-for-sale (3,637) (633,861) (343,295) Maturity or redemption of investment securities available-for-sale 200,000 408,500 815,750 ----------- ----------- ----------- Net cash (used) provided by investing activities (480,814) (147,532) 479,558 ----------- ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Dividends paid (157,034) (102,498) (81,008) Exercise of stock options 126,160 41,835 20,795 Net change in ESOP loan 41,734 (12,600) (20,154) Redemption of common stock (657,150) (473,636) (348,271) ----------- ----------- ----------- Net cash used in financing activities (646,290) (546,899) (428,638) ----------- ----------- ----------- (DECREASE) INCREASE IN CASH (2,893) 2,476 (4,391) CASH AT BEGINNING OF YEAR 3,044 568 4,959 ----------- ----------- ----------- CASH AT END OF YEAR $ 151 $ 3,044 $ 568 =========== =========== ===========
26 TRI-COUNTY FINANCIAL CORPORATION
CORPORATE INFORMATION: Tri-County Financial Corporation Community Bank of Tri-County - ------------------------------------------------------------------------------------------------------------------- DIRECTORS OF BOTH Michael L. Middleton Chairman of the Board C. Marie Brown W. Edelen Gough, Jr. Henry A. Shorter, Jr. Herbert N. Redmond, Jr. Gordon A. O'Neill H. Beaman Smith - ------------------------------------------------------------------------------------------------------------------- OFFICERS OF COMMUNITY BANK OF TRI-COUNTY Michael L. Middleton President and Chief Executive Officer C. Marie Brown Gregory C. Cockerham Eileen M. Ramos Senior Vice President Senior Vice President Chief Financial Officer Chief Operations Officer Chief Lending Officer David D. Vaira John H. Buckmaster H. Beaman Smith Vice President Vice President Secretary/Treasurer - ------------------------------------------------------------------------------------------------------------------- COUNSEL Corporate: Local Counsel: Franklin Goldstein Louis P. Jenkins, Esq. Semmes, Bowen & Semmes P. O. Box 280 250 West Pratt Street La Plata, Maryland 20646 Baltimore, Maryland 21201 (301) 934-9571 (410) 539-5040 Special Counsel: Auditors: Gary R. Bronstein, Esq. Stegman & Company Housley Kantarian & Bronstein, P.C. 405 East Joppa Road, Suite 200 1220 19th Street, NW, Suite 700 Baltimore, Maryland 21286 Washington, DC 20036 (410) 823-8000 (202) 822-9611
FORM 10-K A copy of Form 10-K, including financial statements as filed with the Securities and Exchange Commission will be furnished without charge to stockholders as of the record date upon written request to H. Beaman Smith, Secretary, Tri-County Financial Corporation, P. O. Box 38, Waldorf, Maryland 20604. STOCK TRANSFER AGENT: STOCK TRANSACTIONS AND INQUIRIES: Bank of New York Christy Lombardi, Executive Secretary 101 Barclay Street Community Bank of Tri-County New York, NY 10286 P. O. Box 38 Waldorf, Maryland 20604 1-888-745-BANK, ext. 614 FAX (301) 843-3625 ANNUAL MEETING: May 5, 2000, 10:00 a.m. Community Bank of Tri-County 2nd Floor Board Room 3035 Leonardtown Road Waldorf, Maryland Main Office St. Patrick's Drive Branch - ----------- -------------------------- P.O. Box 38 20 St. Patrick's Drive 3035 Leonardtown Road Waldorf, MD 20603 Waldorf, MD 20604 Bryans Road Branch Campus Center Branch - ------------------ -------------------- P.O. Box 522 Charles County Comm. College 8010 Matthews Road P. O. Box 1810 Bryans Road, MD 20616 8730 Mitchell Road La Plata, MD 20646 Dunkirk Branch La Plata Branch - -------------- --------------- P. O. Box 373 P.O. Box 1810 10321 Southern Maryland Boulevard 9405 Chesapeake Street Dunkirk, MD 20745 La Plata, MD 20646 Leonardtown Branch Lexington Park Branch - ------------------ --------------------- P.O. Box 241 P.O. Box 561 25395 Point Lookout Road 22730 Three Notch Road Leonardtown, MD 20650 California, MD 20619 Berry Road Branch - ----------------- 10195 Berry Road P.O. Box 6265 Waldorf, MD 20603 EX-21 3 SUBSIDIARIES EXHIBIT 21 SUBSIDIARIES OF THE REGISTRANT Parent - ------ Tri-County Financial Corporation Percentage State of Subsidiaries Owned Incorporation - ------------ ----------- ------------- Community Bank of Tri-County 100% Maryland Community Mortgage Corporation of Tri-County (1) 100% Maryland Tri-County Federal Finance One (1) 100% Maryland Tri-County Investment Corporation (1) 100% Delaware - ------------------------- (1) Wholly-owned subsidiary of Community Bank of Tri-County. EX-23 4 CONSENT [LETTERHEAD OF STEGMAN & COMPANY] CONSENT OF INDEPENDENT AUDITORS We hereby consent to the incorporation by reference in the Registration Statement No. 333-79327 on Form S-8, and in the Annual Report on Form 10-K of Tri-County Financial Corporation for the year ended December 31, 1999, of our report dated February 25, 2000, relating to the consolidated financial statements of Tri-County Financial Corporation. /s/ Stegman & Company Baltimore, Maryland March 29, 2000 EX-27 5 FINANCIAL DATA SCHEDULE
9 12-MOS DEC-31-1999 DEC-31-1999 3,469,304 3,063,279 0 0 56,655,300 4,234,472 4,234,472 147,483,466 1,653,290 222,897,280 155,741,800 13,398,378 1,241,719 31,400,000 0 0 7,882 21,107,501 222,897,280 11,562,846 4,197,132 93,352 15,853,330 5,528,672 7,441,179 8,412,151 240,000 (605) 6,276,125 3,167,490 3,167,490 0 0 2,153,490 2.75 2.59 4.11 218,000 171,000 0 0 1,540,551 134,051 6,790 1,653,290 1,653,290 0 0
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